Commercial Debt Forgiveness
What is it?
Division 245 of the Income Tax Assessment Act 1997 contains provisions to tax the benefit that a borrower obtains when a lender forgives a debt owing by the borrower.
Take an example
If a shareholder lends $4 million to his company, then the loan is an asset of the company. The company can demand repayment of the loan in accordance with the loan agreement. Its value is $4m. Prior to making the loan the company had $4m in cash or other assets. After the loan, the company’s rights under the loan agreement are also $4m.
What happens if the company forgives the loan? If the loan is forgiven, then the shareholder is no longer required to repay the loan. That means that the assets of the company are reduced by $4m. It also means that the assets of the shareholder have been increased by $4m.
The commercial debt forgiveness rules mean that the benefits that the shareholder receives are taxed.
Is this relevant to buy-sell arrangements and the insurance that accompanies them?
Some analysts say “yes”. But we say “no”. Have a look at the “Publications” section of our website in the context of different methods of policy ownership. Our article “Commercial Debt Forgiveness and Business Succession” discusses the matter.