Forgiveness of a debt - What are the tax consequences?

This is because the debt owed to you is a “CGT asset” in your hands and its forgiveness gives rise to a “CGT event” – potentially resulting in a capital loss to you (as calculated by reference to the value of the debt owed to you).

This typically occurs where you forgive the debt because the debtor does not have the capacity to repay and the debt has no value at all. On the other hand, where the debt is forgiven, but the debt could be repaid to a greater or lesser extent, then the amount of the capital loss will be reduced accordingly.

However, crucially, the tax law excludes from this, those debts which are not connected with any income producing activity or business – that is, essentially, debts of a “private nature” which typically arise between family members and friends (and even, possibly, in relation to dealings with a family company).

On the other side of the coin is the person who does not have to repay the debt (“the debtor”). In this case, there is no taxable gain to the person because they have not derived income or made a gain. Rather, they have merely had their obligation to repay the debt relieved or extinguished by the forgiveness of it.

Nevertheless, there can be tax law consequences to the debtor in this case.

But once again, there is generally a carve out for debts that do generate assessable income – that is, “non-commercial” debts where either no interest charged or any interest charged on the debt would not have been deductible to the borrower/debtor.

Again, such debts typically arise between family members and related parties.

However, on the other hand, where interest is payable on the debt is and would be deductible to the debtor then the tax rules come into play. And this includes the situation where interest is not charged but, if it had been it would have been deductible to the debtor.

This may arise in various situations and where it does the “commercial debt forgiveness” rules in the tax law come into play.

While these rules do not result in the debtor making any taxable income or gain, they do require the debtor to reduce some existing “tax advantages” they may have by the amount of the debt forgiven.

These tax advantages may include any prior year tax losses or capital losses that they could otherwise carry forward to reduce tax they may have in the future.

Likewise, it can also include the value of depreciable assets that would otherwise give rise to deduction for depreciation used.

Suffice to say these commercial debt rules are quite intricate – even in terms of working out if such a debt exists in the first place. Likewise, the CGT

rules that apply to the creditor on forgiving a debt require close consideration.

So, if you are a debtor or creditor in any debt forgiveness scenario (or are thinking of forgiving a debt), you must come and speak to us about the possible tax consequences – including those that maybe advantageous to you.