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 the 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. However, the circumstances in which this exclusion can apply according to the Commissioner’s view have changed over time. The exclusion has historically been widely used in family group situations. The now withdrawn ATO ID 2003/589 outlined the ATO’s long-standing view that a non-individual creditor could forgive a debt for reasons of natural love and affection.
This ID was withdrawn on 6 February 2019 and the ATO subsequently issued TD 2019/D9 which stated that only a natural person could forgive a debt for reasons of natural love and affection. This determination was in turn finalised on 9 February 2022 as TD 2022/1.
The finalised determination outlines the Commissioner’s view as follows:
10. The second element is comprised in the phrase ‘for reasons of’, which requires a causal nexus between the forgiveness and the natural love and affection. It is not sufficient that there is forgiveness of the debt and there is natural love and affection. The forgiveness must be because of the natural love and affection. The Commissioner takes the view that the causal nexus requires that the forgiveness be for the reason of the natural love and affection felt by the creditor for another natural person.
The ordinary meaning of this phrase imports strong emotions of caring, fondness and attachment that arise in consequence of ordinary human interaction. The term’s legal meaning refers to goodwill towards, or emotional attachment to, another person, particularly that of a parent to their children.
16. As the natural love and affection required for paragraph 245-40(e) to operate must arise in consequence of ordinary human interaction, the object of the creditor’s natural love and affection that is the reason for the debt forgiveness must be another natural person.
17. However, paragraph 245-40(e) does not further require that the object of the creditor’s natural love and affection is also the debtor.
Based on the above, the Commissioner’s view can be distilled as follows:
- Only a creditor that is a natural person can forgive a debt for reasons of natural love and affection.
- In limited circumstances, a natural person being the trustee of a trust or a partner in a partnership may be able to forgive a debt for reasons of natural love and affection. This would however be subject to the overarching fiduciary duties that the trustee or partner has and may thus limit the ability to forgive the debt for natural love and affection.
- The debtor does not need to be a natural person for the purposes of this exclusion in the CDF rules, as long as there is an underlying natural person that is the object of the natural love and affection. For example, this could be applicable where a parent forgives a debt owed by a company that is 100% owned by their child.
If you are interested in getting an in-depth and practical understanding of the CDF rules, you can purchase our record case study session by clicking here ‘Forgiving Debts and UPEs’.