Commercial Debt Forgiveness: loss transfer agreements

Can a loss company validly transfer a prior year tax loss under Subdivision 170-A of the Income Tax Assessment Act 1997 (ITAA 1997) after a commercial debt it owes is forgiven for the purposes of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936), where the deduction year is the forgiveness year of income?

No. Such a tax loss cannot be validly transferred to the extent that it is required to be reduced under Schedule 2C to the ITAA 1936 as a deductible revenue loss of the loss company.

Loss Company incurred a tax loss of $1,000 in the 1998 income year.

On 30 April 1999, Loss Company, as a debtor, was forgiven a commercial debt which resulted in it having a total net forgiven amount of $800 under subsection 245-105(1) of Schedule 2C to the ITAA 1936 for the 1999 forgiveness year.

On 10 July 1999 Loss Company entered into a loss transfer agreement pursuant to Subdivision 170-A of the ITAA 1997, to transfer the $1,000 prior year tax loss in respect of a deduction year ended 30 June 1999.

The loss transfer of $1,000 would satisfy the requirements of Subdivision 170-A of the ITAA 1997, if Schedule 2C of the ITAA 1936 was found to have no impact on the tax loss.

Loss Company has no other prior year tax losses.

Where a commercial debt owed by an entity is forgiven after 27 June 1996, the total net forgiven amount of a debtor for a forgiveness year of income, must be applied in accordance with the commercial debt forgiveness provisions of Schedule 2C to the ITAA 1936, to successively reduce the entity's deductible revenue losses, deductible net capital losses, deductible expenditures and the relevant cost base of certain CGT assets.

The 'total net forgiven amount', as defined by subsection 245-105(1) of Schedule 2C to the ITAA 1936, is the sum of the net forgiven amounts of the debtor, calculated in accordance with Subdivision 245-D of Schedule 2C to the ITAA 1936, for the forgiveness year of income. In this instance, Loss Company has a total net forgiven amount of $800 for the 1999 forgiveness year of income.

Tax losses deductible under sections 36-15 or 36-17 of the ITAA 1997 can be deductible revenue losses as defined in section 245-110 of Schedule 2C to the ITAA 1936. However, tax losses are only deductible revenue losses for the purposes of Schedule 2C to the ITAA 1936 to the extent that they would be an allowable deduction to the debtor in the forgiveness year of income or a later year of income, based on the assumption that the debtor had derived sufficient assessable income.

Schedule 2C to the ITAA 1936 does not precisely state when a debtor must quantify its deductible revenue losses. Subsection 245-105(4) of Schedule 2C merely provides that a debtor's total net forgiven amount is to be applied before the debtor furnishes the Commissioner with their return in respect of the forgiveness year.

A debtor could generally calculate the net forgiven amount in respect of a forgiven debt at the time of forgiveness. However it cannot with relative certainty calculate its total net forgiven amount in respect of all forgiven debts until the forgiveness year of income has ended.

Accordingly, the Commissioner reasonably considers that a debtor's deductible revenue losses are to be ascertained by reference to such losses that are in existence immediately after the end of the forgiveness year of income.

Subsection 170-45(1) of the ITAA 1997 provides that a loss company cannot transfer an amount of a tax loss in excess of the amount that it would have carried forward to its next income year, if it did not make the loss transfer.

If the company did not make the loss transfer, the $1,000 prior year tax loss would be a deductible revenue loss as defined by section 245-110 of Schedule 2C of the ITAA 1997. As a result, the $1,000 prior year loss is reduced by the total net forgiven amount of $800 to $200 pursuant to subsection 245-105(5) of Schedule 2C to the ITAA 1936.

Therefore, the loss transfer agreement is only effective in transferring the remaining $200 prior year tax loss, pursuant to Subdivision 170-A of the ITAA 1997, as this is the only amount of tax loss that it would have been able to have carried forward to the next income year if the loss transfer agreement had not been made (Taxation Ruling TR 98/12 details the Commissioner's view on loss transfers, in particular see paragraph 96 - insufficient loss example).