Commercial Debt Forgiveness - whether thin capitalisation rules are exception provision

Does a debt constitute a commercial debt pursuant to section 245-25 of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) where interest paid in respect of the debt would be allowable as a deduction apart from the operation of Division 820 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The debt is a commercial debt because Division 820 of the ITAA 1997 is an exception provision for the purposes of subsection 245-25(2) of Schedule 2C to the ITAA 1936.

Debtor executed a loan agreement with Lender.

Interest paid in respect of the loan is not deductible to Debtor because of the operation of Division 820 of the ITAA 1997.

After 27 June 1996, Lender formally released Debtor from repaying the loan.

Section 245-10 of Schedule 2C to the ITAA 1936 provides that Schedule 2C applies where a forgiveness of a commercial debt occurs after 27 June 1996.

The term 'commercial debt' is defined in section 245-25 of Schedule 2C to the ITAA 1936.

Paragraph 245-25(2)(b) of Schedule 2C to the ITAA 1936 provides that a debt is a commercial debt if the whole or any part of interest paid or payable in respect of the debt would be allowable apart from the operation of an exception provision.

The term 'exception provision' is defined in subsection 245-25(5) of Schedule 2C to the ITAA 1936 as follows: 'exception provision means a provision of this Act that has the effect of preventing a deduction that would otherwise be allowable, but does not include paragraphs 8-1(2)(a), (b) and (c) of the Income Tax Assessment Act 1997 (which prevent deductions for capital, private or domestic outgoings and for outgoings relating to exempt income).'

Division 820 of the ITAA 1997 is therefore an exception provision for the purposes of paragraph 245-25(2)(b) of Schedule 2C to the ITAA 1936

Accordingly Schedule 2C to the ITAA 1936 applies to the forgiveness of the commercial debt owed by Debtor to Lender.