Income Tax: Consolidation: Single entity rule and commercial debt forgiveness

Do the commercial debt forgiveness rules in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997), apply where a commercial debt owed by a member of a consolidated group is forgiven by another member of the same consolidated group?

No. The single entity rule (SER) in section 701-1 of the Income Tax Assessment Act 1997 (ITAA 1997) will prevent Division 245 of the ITAA 1997 from applying to the head company where a commercial debt owed by a member of a consolidated group is forgiven by another member of the same consolidated group.

Finance Co and Borrower Co are wholly owned by Head Co.

Prior to Head Co's election to form a consolidated group, Finance Co lent funds to Borrower Co for an investment (the debt is a commercial debt), which ultimately went bad. Finance Co claimed a deduction under section 25-35 of the ITAA 1997 but no forgiveness of the debt occurred at that time for the purposes of section 245-35 of the ITAA 1997.

Head Co and its subsidiaries, including Finance Co and Borrower Co, formed a consolidated group. The loan owing from Borrower Co to Finance Co is waived, released or otherwise extinguished, after the date of consolidation.

Prima facie, the release, waiver or extinguishment of the debt by Finance Co gives rise to commercial debt forgiveness for the purposes of Division 245 of the ITAA 1997. However, due to the operation of the single entity rule contained in section 701-1 of the ITAA 1997, the forgiveness of the debt, which in this case comprises the cessation of rights and obligations between members of a consolidated group, is ignored.

The debt forgiveness is ignored because the single entity rule deems subsidiary members to be parts of the head company rather than separate entities during the period that they are members of the consolidated group (an entity cannot transact with itself). Taxation Ruling TR 2004/11 at paragraph 8 states: Consequently, the SER has the effect that: (a) the actions and transactions of a subsidiary member are treated as having been undertaken by the head company; (b) the assets a subsidiary member of the group owns are taken to be owned by the head company (with the exception of intra-group assets) while the subsidiary remains a member of the consolidated group; (c) assets where the rights and obligations are between members of a consolidated group (intra-group assets) are not recognised for income tax purposes during the period they are held within the group whether or not the asset, as a matter of law, was created before or during the period of consolidation; and (d) dealings that are solely between members of the same consolidated group (intra-group dealings) will not result in ordinary or statutory income or a deduction to the group's head company.

Accordingly, the forgiveness of the loan is not recognised for the purposes of other provisions of the income tax law, including Division 245 of the ITAA 1997. This intent is clearly articulated in TR 2004/11 at paragraphs 26, 27, 32 and 33.