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Where a creditor forgives a commercial debt as part of a settlement agreement and also pays the debtor an additional amount under the agreement that is assessable income of the debtor, does that amount reduce the gross forgiven amount of the debt under paragraph 245-85(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The additional amount will not reduce the gross forgiven amount of the debt under Paragraph 245-85(1)(a) of the ITAA 1997.

The taxpayer entered into a business arrangement with an unrelated entity. As part of the arrangement the taxpayer owed a commercial debt to the entity (the creditor).

The taxpayer threatened to sue the creditor for misrepresentation in relation to the business arrangement. The dispute was settled by formal agreement between the parties after 1 July 2010.

Under the agreement the creditor forgave the balance of the commercial debt owed by the taxpayer at the time of the agreement and also paid an additional settlement amount to the taxpayer.

The forgiven amount of debt was not assessable income of the taxpayer.

The additional settlement amount paid was assessable income of the taxpayer.

Neither party is in the business of moneylending.

Division 245 of the ITAA 1997 applies to any commercial debt that has been forgiven after 1 July 2010.

Under paragraph 245-85(1)(a) of the ITAA 1997 the gross forgiven amount of a debt is reduced by: any amount that, under a provision of this Act other than this Division, has been, or will be, included in your assessable income for any income year as a result of the forgiveness of the debt.

The phrase 'included in the assessable income for any income year as a result of the forgiveness of the debt' refers to a situation where the forgiveness of the debt results in an amount being included in your assessable income. There must be a causal connection between the forgiveness of the debt and the amount being included in assessable income.

In this case, the additional amount is separate from the debt forgiveness. The additional amount is a payment made as a result of the settlement agreement. The forgiveness of the debt is also part of the terms of the settlement agreement. The forgiveness of the debt did not cause the amount to be included in the assessable income of the taxpayer.

As the amount being included in the assessable income of the taxpayer did not 'result from the forgiveness of the debt', that amount does not fall within paragraph 245-85(1)(a) of the ITAA 1997.

Note: Section 245 of the ITAA 1997 replaced section 245-10 of Schedule C to the Income Tax Assessment Act 1936 (ITAA 1936). Although section 245 of the ITAA 1997 is effective from 1 July 2010, the provision is identical to section 245-10 of Schedule C to the ITAA 1936, which was effective from 27 June 1996.