Commercial debt forgiveness: gross forgiven amount

Where a creditor forgives a commercial debt and pays the debtor an additional amount that constitutes assessable income of the debtor, does that amount, reduce the gross forgiven amount of the debt, under paragraph 245-85(1)(a) of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936)?

No. Paragraph 245-85(1)(a) of Schedule 2C to the ITAA 1936 only contemplates situations where an amount of the forgiven debt itself, rather than associated payments by the creditor, constitutes assessable income of the debtor.

Debtor incurred a commercial debt as defined in section 245-25 of Schedule 2C to the ITAA 1936 as part of an overall arrangement with Creditor concerning a primary production business ('the business') that was organised by Creditor.

As the business was not as profitable as Creditor had led Debtor to believe, Debtor threatened to sue Creditor for misrepresentation. That dispute was resolved by formal agreement ('the agreement') between the parties after 27 June 1996.

Pursuant to the agreement Creditor forgave Debtor the balance of the debt that was outstanding at the time of the agreement. The forgiven amount of the debt did not constitute assessable income of Debtor. Furthermore, Creditor paid Debtor a sum of money, as part of the settlement, which constituted assessable income to Debtor.

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

Paragraph 245-85(1)(a) of Schedule 2C to the ITAA 1936 provides that 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 the debtor's assessable income of any year of income as a result of the forgiveness of the debt.

Schedule 2C to the ITAA 1936 is designed to rectify, to some extent, the common lack of symmetry between the tax situations of debtors and creditors where a commercial debt is forgiven. Whilst it is appropriate that creditors are entitled to capital (or revenue) losses in respect of any economic loss incurred in respect of the forgiven debt, generally debtors are not subject to commensurate capital (or revenue) gains for their associated economic gain flowing from the forgiveness.

Where all or part of a forgiven debt does in fact constitute assessable income of a debtor, paragraph 245-85(1)(a) of Schedule 2C to the ITAA 1936 operates to ensure that Schedule 2C to the ITAA 1936 is not inappropriately applied to that extent, as the desired symmetry already exists.

In the present circumstances Debtor is not being assessed on the amount of forgiven debt and therefore a symmetry does not exist between the tax positions of Debtor and Creditor in relation to the forgiveness.

The additional sum of money paid by Creditor to Debtor does not help to create the symmetry and it is therefore inappropriate to take that amount into account under paragraph 245-85(1)(a) of Schedule 2C to the ITAA 1936.