Commercial Debt Forgiveness - interaction with Subdivision 165-CD of the Income Tax Assessment Act 1997 - deductible revenue losses

Where a loss company is calculating the amount of its undeducted tax losses for the purposes of subsection 165-115R(5) of the Income Tax Assessment Act 1997 (ITAA 1997), does that amount reflect any reduction to those losses that may be subsequently required as a debtor to be made under Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. The reductions made by Schedule 2C to the ITAA 1936 to tax losses as deductible revenue losses have the effect of deeming such reduced losses as not having been incurred by the debtor.

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

Loss Company has the following undeducted tax losses before considering the application of Schedule 2C to the ITAA 1936: • $40,000 in respect of the year of income ended 30 June 2001 • $50,000 in respect of the year of income ended 30 June 2002

On 1 December 2002, Loss Company has a forgiveness of a commercial debt that it owes. As a result of that forgiveness, Loss Company has a total net forgiven amount of $100,000 under subsection 245-105(1) of Schedule 2C to the ITAA 1936.

These abovementioned $40,000 and $50,000 tax losses constitute the only deductible revenue losses that Loss Company has for the purposes of section 245-110 of Schedule 2C to the ITAA 1936 for the forgiveness year of income.

Apart from those amounts, the only other amount that Loss Company is required to take into account in calculating its overall loss under subsection 165-115R(5) of the ITAA 1997 is $60,000 of unrealised losses under paragraph 165-115R(3)(e) of the ITAA 1997.

Subsection 165-115ZA(3) of the ITAA 1997 requires that the reduced cost base of an equity or debt interest is to be reduced immediately before the 'relevant time.'

In this case, subsection 165-115ZA(3) of the ITAA 1997 provides that the 'relevant time' is the alteration time that was identified by section 165-115L of the ITAA 1997.

Schedule 2C to the ITAA 1936 does not precisely state when its adjustments are to take effect.

Under Schedule 2C to the ITAA 1936, the undeducted tax losses of $40,000 and $50,000 will both be reduced to zero by section 245-115 of Schedule 2C of the ITAA 1936 through applying Loss Company's total net forgiven amount of $100,000.

Whilst such reductions do not occur until after the end of the forgiveness year of income, they have the effect of retrospectively reducing the tax losses as calculated, in this instance to zero, rather than merely prospectively reducing the undeducted balance(s) of those losses.

Accordingly, in calculating Loss Company's overall loss under subsection 165-115R(5) of the ITAA 1997 the $50,000 and $40,000 tax losses will not be taken into account by that subsection, and Loss Company's overall loss will be $60,000.