On 6 February 2019, the ATO withdrew ATO ID 2003/589 which outlined its longstanding view that a non-individual creditor could forgive a debt for reasons of natural love and affection. In the past, many practitioners relied on this exception in family group situations where, for instance, the director of a creditor company would forgive a debt owing from a member of the director’s family group for reasons of natural love and affection. The ‘controlling mind’ of the creditor was relevant in determining the motivation for the debt forgiveness. That is, the love and affection underpinning the debt forgiveness could ultimately be traced to an individual.
On 2 October 2019, the ATO released TD 2019/D9 which states that only a natural person can forgive a debt for reasons of natural love and affection. The shift in the ATO’s view is based on the need for natural love and affection to arise in consequence of ordinary human interaction. It is now the ATO’s view that the motivation for a debt forgiveness can only be satisfied when the creditor feels the natural love and affection.
The commercial debt forgiveness (CDF) rules in Division 245 of the ITAA 1997 have some potentially nasty tax implications whereby the tax attributes of a debtor could be adversely affected. Although the CDF rules do not make the amount of debt forgiven assessable to the debtor, carried forward tax and capital losses, the value of depreciating assets and cost base of CGT assets could be reduced by the forgiven amount. The rules are complex and contain multi-tiered tests to work out the net forgiven amount applicable.
The natural love and affection exception is a convenient way to exit the CDF testing and its application. Interestingly, this exception has been heavily relied upon in family break-up situations where debt forgiveness is common. Often, trusts or companies are required under Family Court orders to forgive debts owing from spouses. In the past, practitioners would rely on the ATO’s previously stated view that companies and trusts could forgive such debts for reasons of natural love and affection (although, love and affection would arguably not be present at the time of forgiveness).
Based on the view expressed by the ATO in TD 2019/D9, we strongly recommend that all practitioners revisit their reliance on the natural love and affection exception for debts forgiven after 6 February 2019. The ATO has expressed that it will not devote any compliance resources to the review of this exception for debts forgiven by companies or trusts before this date.