Deed of Debt Forgiveness – no tax consequences

The ATO released Draft Taxation Determination 2019/D9. This is over 7 months since it withdrew ATO ID 2003/589 on 6 February 2019.

In TD 2019/D9, the ATO now takes the view that the exclusion for debts forgiven for natural love and affection are only between human beings – not companies or trusts.

The ATO’s new view is that “the creditor cannot be a company or an individual acting in the capacity of a trustee”.

As part of the explanation of the ATO’s view, it notes that “the notion of forgiveness is confined by the use of ‘natural love and affection’. That term serves to identify the motivation for forgiveness. The required connection between that motivation and forgiveness is only satisfied when the creditor feels natural love and affection.” It is a human trait. While you can love your car and your dog, perhaps you cannot love your company and your trust! The ATO has made its way into your home and now into your bedroom. The ATO now claims to know your inner thoughts.

TD 2019/D9 turns on its head the ATO’s old interpretation of section 245-40(e) ITAA 1997.

Have a read of section 245-40(e). There is no requirement that a creditor is a natural person. The only reason for forgiveness is ‘natural love and affection’.

However, the ATO does not “devote compliance resources to debt forgiven prior to 6 February 2019″. However, Deeds of Debt forgiveness for companies and trust after that date may well be legal, but incur the wrath of the ATO. Tread carefully. Family Court decisions since 6 February 2019 may have to be reconsidered if there was forgiveness of debt.

Note the ATO’s position is that neither a trust nor a company, as the creditor, can express ‘feelings’ such as ‘love’ and ‘affection’. It may still be possible for a human being, such as a beneficiary to forgive a debt to a company, or, as is more usually a family trust. We will see what the ATO has in store for us, in due course.

What is a Deed of Debt Forgiveness?

The Borrower owes you money. You, as the Lender, sign the Deed of Debt Forgiveness. The debt is gone. The Borrower no longer owes you, the Lender any money.

Does the Deed of Debt Forgiveness also get rid of Family Trust – Unpaid Present Entitlements (UPEs)?

Discretionary trusts offer flexibility, asset protection and tax savings. Beneficiaries don’t have an interest in the trust property until an ‘entitlement’ is created by the trustee. That ‘entitlement’ is known in the tax system as a ‘present entitlement’. The beneficiary with the present entitlement pays tax on the income. However, rarely does the trust ever pay the money to the beneficiary. Instead, the income is retained in the trust. Instead, the beneficiary gets an Unpaid Present Entitlement (UPE).

At any time the beneficiary, or the Family Court or the Bankruptcy Court can ask for the money. The Trust must hand the money over.

The build-up of UPEs over the years are recipe for disaster if the beneficiary:

1. falls out with you

2. dies

3. gets divorced

4. goes bankrupt

However, the beneficiary is at liberty to forgive the UPEs. Just start building this Deed of Forgiveness. As with most trust arrangements, any steps taken to deal with beneficiary entitlements need to be properly documented via a Deed. The Deed of Debt Forgiveness complies. However, thanks to the ATO the Deed is no longer protected by the ‘natural love and affection’ rule. Use this document with caution and only with your accountant’s involvement.

Example

Your Family Trust distributes $30,000 to your daughter each year for 10 years. Your Family Trust pays the tax of $2,000 per year on behalf of your daughter to the Australian Taxation Office. Therefore, there is an ‘Unpaid Present Entitlement’ (like a debt). Your Family Trust owes your daughter $280,000. An ‘Unpaid Present Entitlement’ is the money that the Family Trust owes the beneficiary. You can now forgive Family Trust UPEs using a Deed of Debt Forgiveness.

Your daughter, of course, never gets any of this $280,000. You just used her low marginal tax rates to pay less tax. Your accountant reminds you that your daughter (or her ex-husband or trustee in bankruptcy) can now ask for that money. After all, it is her money. At any time your daughter can tell you she wants the money. And you have to pay her.

To get rid of the debt she signs a Deed of Debt Forgiveness. There are no tax issues when forgiving the debt. Get her to sign the same Deed of Debt Forgiveness each financial year. Therefore, if your daughter goes bankrupt, feral, divorces or dies your Family Trust owes her nothing.

Have a son? Have other children? Distributed to yourself? Build a separate Deed of Debt Forgiveness for each of you.

Any income tax issues for a Deed of Debt Forgiveness?

When you forgive a debt for ‘love and affection’:

* is a deduction for the release of debt available?
* do the commercial debt forgiveness penalties apply?
* any FBT?

The answer to all questions is ‘we don’t know’. The ATO have withdrawn their liberal views of what is ‘natural love and affection’.

Commercial Debt Forgiveness and ‘love and affection’

Division 245 ITAA 1997  sets out the tax for a debtor. This is when a commercial debt is forgiven.

However, a debt that is forgiven for ‘natural love and affection’ is excluded (section 245-40). Our Deed of Debt Forgiveness is drafted by us on that basis. But the ATO no longer believes that you can have ‘natural love and affection’ between a trustee (whether a company or a human) and a human.

When do Reimbursement Agreement rules apply to debt forgiveness?

We do not use Reimbursement Agreements to forgive debts. They don’t work. See the Sample above to read our letter of advice on this point.

This document works for:

1. when a child forgives a debt owed by a parent

2. when a parent forgives a debt owed by a child

3. when a human forgives a debt that a company owes it

4. when a beneficiary (other than a company) forgives the debt that the Family Trust owes the beneficiary (forgiving a UPE)

What about Division 7A Loans?

This Deed of Debt Forgiveness is not appropriate when you or your trust owes money to a company. That is probably a Division 7A loan that your company should not forgive. Get your accountant and financial planner to telephone us.

Any Stamp Duty?

You do not need to lodge this document in the ACT, WA, VIC, NSW, TAS, NT, QLD or SA. There is no duty payable in those States.

How do I record forgiveness of debt in the accounts?

When you build the Deed of Forgiveness Deed you get a letter of advice. Forgiving the debt is neither income nor a taxable capital gain. It has no tax consequences. The forgiven amount ends up in the trust corpus. For the accounts, to be true and useful, the accounts should reflect this. The letter of advice sets out the Journal Entries that your accountant needs. Our letter of advice is kept by your accountant as part of the due diligence file.

Question: My son is getting married

My son is getting married. I want to reduce his balance in his loan account in the family trust to nil. ie forgive the unpaid present entitlements. The balance has been accumulating over the years as the actual distributions are much less than the taxable income of the trust which has been distributed to him.

Answer: you should have been doing this on an annual basis. You should not have allowed it to have built up. It may already be an asset of the defacto/marriage. In future get him to forgive the debt each year. To do otherwise is lazy on your part.

Question: I don’t know how much the debt is

I am not sure how much the debt is. We will need to go through the records.

Answer: You are best to start building the document as it answers such basic questions in more detail. The Deed of Debt Forgiveness does not state an amount forgiven. Rather, whatever the amount is, is now forgiven. You need to look to your accounts as to how much is owed – that amount is forgiven. This is each time the beneficiary signs and dates the Deed of Debt Forgiveness. You need to keep working on the accounts until you get the correct amount of the debt.

Question: not a reimbursement agreement

In relation to the trust UPE forgiveness for the adult child, can the trustee later resolve to distribute the reserve or capital account “UPE’s Forgiven” created on the UPE debt forgiveness in cash tax-free to other beneficiaries eg the parents, to clear the capital of the trust? What about reimbursement agreements?

Answer: No, that should not be done. As the letter of advice, that comes with the Deed, states you should not use reimbursement arrangements. Have a look at the sample to see the full answer. Instead, you are building a Deed of Debt Forgiveness, not a reimbursement agreement.

Question: Forgiving a debt vs writing off a bad debt

Do you have an online Deed of Debt Forgiveness for a loan by a director to a private company? This is where forgiveness is made not for natural love and affection. This is on the basis that the debt is not recoverable. This is because the company has significant tax losses and will be deregistered in the year after the forgiveness is processed.

Answer: just like any bad debt it is written off in the usual course. To prove it is a bad debt build and post a Letter of Demand and draft Writ: https://www.legalconsolidated.com.au/debt-recovery/

 


For more legal advice telephone us. We are a law firm. We can help you answer the questions to build this Deed.

Debt Forgiveness agreement deed

Adjunct Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
National Australian law firm
Mobile:        0477 796 959
National:    1800 141 612
Email:          [email protected]


Loan to a Parent:

Loan to a Spouse:

Commercial Loan Agreement:

Loan to a Company:

ATO Compliant Loan Agreement:

Loan to a Child:

Division 7a Loan Deed:

11/11/2016

Deed of Debt Forgiveness – no tax consequences

The ATO released Draft Taxation Determination 2019/D9. This is over 7 months since it withdrew ATO ID 2003/589 on 6 February 2019. In TD 2019/D9, the ATO now takes the view that the exclusion for debts forgiven for natural love and affection are only between human beings – not companies or […]