Issue
Where an entity exits a consolidated group with a liability that is owed to a non-group member, will the commercial debt forgiveness rules in Division 245 in Schedule 2C of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the head company of that consolidated group?
Decision
No. The commercial debt forgiveness rules in Division 245 in Schedule 2C of the ITAA 1936 will not apply to the head company of a consolidated group when a member of the group exits that group, taking a liability owed to a non-group member with it.
Facts
As part of an arrangement, an Australian resident entity that is a member of a consolidated group issues a debt instrument to an entity that is not a member of the consolidated group. The debt instrument raises an obligation on the issuer to pay the holder all amounts of principle, interest and other amounts payable in respect of the debt instrument.
During the time that the non-member entity holds the debt instrument, the issuer of the debt instrument exits the consolidated group as a result of the exercise of a call option held by the debt instrument holder over shares in the issuer.
Reasons for Decision
While the entity that issues the debt instrument remains a member of the consolidated group, its liabilities under the debt instrument are treated as liabilities of the head company of the group for the purposes of determining the income tax liability of the head company, that is, for head company core purposes as provided in subsection 701-1(2) of the Income Tax Assessment Act 1997 (ITAA 1997). This is due to the operation of the single entity rule in section 701-1 of the ITAA 1997.
When the entity that issues the debt instrument leaves the consolidated group, its liabilities under the debt instrument are again recognised as its own for the purposes of determining its income tax liability once outside the group, that is, for entity core purpose as provided in subsection 701-1(3) of the ITAA 1997. This is due to the operation of the exit history rule in section 701-40 of the ITAA 1997 and the fact that the single entity rule ceases to apply to the exiting entity.
The cessation of the application of the single entity rule to the exiting entity in relation to the consolidated group will not of itself trigger the operation of the debt forgiveness rules in relation to the head company of that consolidated group.
Only the non-member entity, as holder of the rights to have the issuing entity's obligations under the debt instrument met, is in the position to forgive those obligations. Further, the debt forgiveness rules in Division 245 of Schedule 2C of the ITAA 1936 will only apply if the non-member entity forgives the obligations under those debt instruments in accordance with the definition provided in clause 245-35 of Division 245 of Schedule 2C of the ITAA 1936.