Issue
When a guarantor becomes liable to repay a creditor under a contract of guarantee and the creditor subsequently forgives the liability of the guarantor, is the liability forgiven a 'commercial debt' for the purposes of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936)?
Decision
No. The provisions of Schedule 2C to the ITAA 1936 do not apply to the liability forgiven.
Facts
A guarantor signed a contract of guarantee on 1 July 2000 agreeing to pay any amount outstanding by the debtor to the creditor in the event of default by the debtor.
The debtor later defaulted and the creditor sought to exercise their rights under the contract of guarantee. The guarantor was unable to meet their obligations under the contract of guarantee.
The creditor released the liability of the guarantor by formal deed. As at the date of release the guarantor had no economic value, and had carried forward net capital losses.
The guarantor was not in the business of entering into contracts of guarantee and had any interest been paid or payable by the guarantor, it would not have been deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).
Reasons for Decision
The amount owing by the Guarantor to the creditor pursuant to the guarantee is an enforceable obligation imposed by law and constitutes a debt for the purposes of section 245-15 of Schedule 2C to the ITAA 1936.
For Schedule 2C to the ITAA 1936 to apply to the forgiveness of a debt, section 245-10 of Schedule 2C to the ITAA 1936 requires that the debt be a commercial one.
Subsection 245-25(3) of Schedule 2C to the ITAA 1936 provides that a debt on which no interest is payable constitutes a commercial debt if, had interest been payable, the whole of any part of the interest would have been allowable as a deduction to the guarantor. Accordingly, the amount owing by the guarantor to the creditor is not a commercial debt and Schedule 2C to the ITAA 1936 does not apply.