Sometimes, tax concessions are gone, gone, gone!
There are many situations where family members have loans owing to a family company that they control. When a need arises to rationalize the loan arrangements in conjunction with a family law settlement, the taxation implications can be critical.
There has been some concern expressed about the ATO’s recent withdrawal of its long standing Interpretative Decision 2003/589 which provided that a family company can forgive a loan owed by a natural person for reasons of “natural love and affection” and not trigger any adverse taxation consequences under the commercial debt forgiveness rules.
While the ATO has given no reason for the withdrawal of the Interpretative Decision, it is worth noting that the forgiveness of a loan owing to a company is also subject to Division 7A. In the event a forgiven amount is assessable under Division 7A, the commercial debt forgiveness rules have no application and any change in the ATO’s position about “natural love and affection” maybe somewhat academic.
Where a family member has a loan owing to a company there are two factual circumstances to consider:
1. Commercial debt forgiveness rules
Where in conjunction with the settlement process, a family company loan, owing by a family member, is to be forgiven, prima facie the amount forgiven is applied in the year of forgiveness to reduce the person’s:
- Carried forward tax losses
- Carried forward capital losses
- Written down value of depreciable assets
- Cost base of CGT assets
As a result of any reduction, a person may incur a higher tax liability in a future year.
The commercial debt forgiveness rules do not apply where the debt is forgiven for reasons of “natural love and affection”. Prior to the withdrawal of ID 2003/589, the ATO accepted that a company could forgive a loan to a family member for reasons of “natural love and affection”.
2. Division 7A
Since the ATO’s Taxation Ruling TR 2014/5 which provided that the s 109J exclusion does not apply to a “payment” made pursuant to a Family Court order, even if the order is binding on the private company (such that the obligation requirement in s 109J(a) is satisfied), family law settlements are now more tax sensitive where company property is to be transferred to a family member.
Where a company has a distributable surplus and forgives a loan owing by a family member, the amount forgiven is assessed as an unfranked dividend in the hands of the debtor. The “natural love and affection” exemption does not apply to Division 7A.
In practical terms, any change in the ATO’s position concerning the “natural love and affection” exemption should only trigger the commercial debt forgiveness rules where a family company does not have a distributable surplus, whereby Division 7A has no application.
If you are involved in a family law settlement involving loans from family entities (companies and trusts) to family members (including associates of family members), it is critical to understand the taxation issues and the implications for your client and to be certain that the most appropriate commercial outcome is achieved.