Commercial Debt Forgiveness - interaction with Subdivision 165-CD of the Income Tax Assessment Act 1997 - reduced cost base

Does Subdivision 165-CD of the Income Tax Assessment Act 1997 (ITAA 1997) require reductions to the reduced cost base of a relevant debt interest owed to an affected entity, if Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) also applies to a subsequent forgiveness of that debt?

No. Subsection 165-115ZA(2) of the ITAA 1997 provides that any reductions in respect of the affected entity's relevant debt interest are taken not to have occurred or to have been required to occur where section 245-10 of Schedule 2C to the ITAA 1936 applies.

Due to changes in its shareholders Loss Company has an alteration time under section 165-115L of the ITAA 1997 on 1 January 2002.

In respect of that alteration time Loss Company has an overall loss under subsection 165-115R(5) of the ITAA 1997 comprising of: • $200,000 of undeducted tax losses under paragraph 165-115R(3)(a) of the ITAA 1997 in respect of the income year ended 30 June 2001 and; • $100,000 of unrealised losses for the purposes of paragraph 165-115R(3)(e) of the ITAA 1997 at the alteration time.

Creditor Company has a controlling stake (as defined in section 165-115Z of the ITAA 1997) in Loss Company immediately before the alteration time. After the alteration time Creditor Company no longer has such a controlling stake.

Creditor Company has a 'relevant debt interest' as defined in subsection 165-115Y(1) of the ITAA 1997 of $20,000 in Loss Company.

For reasons unrelated to the change in ownership of Loss Company, it was released from part of that $20,000 debt on 6 June 2002.

Section 245-10 of Schedule 2C to the ITAA 1936 applied to the forgiveness of the forgiven part of the debt as it was a commercial debt under section 245-25 of Schedule 2C and the release of the debt constituted a forgiveness of the debt under subsection 245-35(1) of Schedule 2C. This resulted in Loss Company having a net forgiven amount under Schedule 2C to the ITAA 1936.

As explained in subsection 165-115K(1) of the ITAA 1997, Subdivision 165-CD of the ITAA 1997 applies where an alteration time occurs in respect of a company that is a loss company at the alteration time, and one or more entities had relevant equity interests or relevant debt interests in the company immediately before the alteration time.

Loss Company in this instance, has an alteration time as defined in section 165-115L of the ITAA 1997 on 1 January 2002.

Loss Company is a 'loss company' as defined in subsection 165-115R(3) of the ITAA 1997 due to its undeducted tax losses and unrealised losses.

The $20,000 debt that was subject to a forgiveness after the alteration time constitutes a 'relevant debt interest' as defined section 165-115Y of the ITAA 1997 in Loss Company.

As such, Creditor Company is an 'affected entity' as defined in subsection 165-115ZA(1) of the ITAA 1997.

However, subsection 165-115ZA(2) of the ITAA 1997 provides that no reductions are required to be made under section 165-ZA of the ITAA 1997 to the reduced cost base of the relevant debt interest owed to Creditor Company, because section 245-10 in Schedule 2C to the ITAA 1936 also applies to the debt.