Just in time for Valentine’s Day, the three year saga over a company’s emotional abilities has come to an end. The Australian Taxation Office (ATO) has finalised its views that companies cannot forgive debts ‘for reasons of natural love and affection’.
While this is not new news at this point, it provides the final “nail in the coffin” so to speak. This is particularly relevant in business break-up situations and family law cases, where these rules have been relied on heavily in the past.
A brief history
The commercial debt forgiveness rules were introduced in 1996 to resolve a perceived disparity in tax consequences on the forgiveness of loans. One exemption to the tax implications that arose under these rules was where the loan could be forgiven by the creditor ‘for reasons of natural love and affection’. In mid-2003 the ATO published their non-binding comments, noting they believed that a debt from a company could be forgiven for reasons of natural love and affection, and this exemption could therefore apply. This interpretation was widely used in family breakdowns, in mitigating the tax implications of separation.
However, in February 2019, the ATO withdrew their previous comments, creating uncertainty for taxpayers. Those in the family law and business break-up space were left in limbo, and had to tread carefully while waiting for further ATO guidance. Read February 2019 update.
Eight months later, the ATO released their draft tax determination, indicating their intent to deny the exemption where the creditor was not a natural person. Read October 2019 update.
What followed was an almost two and a half year wait for any final confirmation. However, the ATO has now reaffirmed that they do not believe a company is capable of feeling ‘natural love and affection’, and therefore the exemption cannot apply to corporate creditors.
What changed from the draft?
Although the ATO has not deviated from its draft comments that companies (as the creditors) cannot forgive debts ‘for reasons of natural love and affection’, they have made two important clarifications to their views:
- They noted that in limited situations, a natural person may forgive a debt ‘for reasons of natural love and affection’ in their capacity as a trustee of a trust, or as a partner in a partnership. There may be some potential application for these rules in situations for family and business break-ups, however care needs to be taken to ensure that the relevant legal and contractual principles and obligations are not contravened.
- They also clarified that the debtor need not be a natural person and therefore, there could be situations where an individual forgives a debt to a company/trust/partnership. However, the ATO affirms that ‘natural love and affection’ arises “in consequence of ordinary human interaction”, and therefore the ‘natural love and affection’ must be felt towards another individual. Accordingly, an individual cannot feel ‘natural love and affection’ towards a structure, but could forgive a debt to a structure as motivated by the ‘natural love and affection’ felt towards an individual.
It is important to consider in each case whether this causal link exists, and care should be taken when applying the exemption for non-individual debtors.
What does this mean going forward?
It comes as a somewhat fitting end, as almost exactly this time three years ago (just before Valentine’s day again), the ATO withdrew their previous guidance and threw advisors and taxpayers into a lovelorn wait. But the wait has ended, and with the extra guidance we now have, we must consider how to move forward.
Advisors need to take care when clients are looking at forgiving debts and wanting to rely on this particular exemption. Albeit some pathways may still exist, it may be that alternatives to forgiving debts are now preferred, particularly where entities are involved.
Forgiveness of debt is no longer a simple, low risk alternative. Instead consideration of other options, such as whether the debt can be assigned to the other spouse or otherwise dealt with, may be required.