ATO confirms loans put on hold during COVID-19 are not subject to debt forgiveness

5 minute read  06.08.2020 Adrian Varrasso, James Momsen, Revell Norquay

Merely putting a loan on hold (either postponing or deferring the amount of principal  to be repaid under the terms of the loan), does not amount to debt forgiveness for tax purposes, according to the recent ATO clarification.  

In line with pre COVID-19 rulings, the ATO considers that for tax purposes a debt is forgiven if:

  • the debtor is relieved from the legal obligation to repay the debt; or
  • the creditor will not demand repayment of the debt (there must be evidence).

What the ATO announcement does not say

Whilst a helpful guide, the brief ATO announcement, is short on some details such as:

  • The title of the ATO announcement refers to deferrals 'during COVID-19', making the scope of the announcement unclear. This is not surprising given the uncertainty surrounding future waves of COVID-19.
  • The announcement states that a postponement of itself will not amount to a forgiveness 'for tax purposes', but then goes on to cite Division 7A. It is unclear if the broad reference to 'tax purposes' encompasses all areas of income tax, for example, commercial debt forgiveness, and other areas, such as fringe benefits tax.
  • The phrases 'put on hold', 'allowing more time to pay' and 'postpones an amount payable' are used by the ATO in their announcement. As there is a broad range across industry practice of different forms of variations between borrowers and lenders, practical examples would have provided greater clarity. For example, guidance on whether a maximum period of deferral would amount debt forgiveness for tax purpose would help in answering questions such as: Would a deferral of 10 years make a difference? Does a deferral of a particular kind amount to an in-substance release, waiver, or extinguishing of the debt?
  • What evidence is required to determine that the creditor will no longer rely on the obligation for repayment, and whether the ATO view of this has changed.
  • In the announcement the ATO uses the phrase 'without more' in reference to a creditor allowing a period of deferral. No further information has been provided regarding what the 'more' is that would be sufficient, in the ATO view, to take this out of deferral territory and into debt forgiveness territory.

Be alert to other issues

The announcement highlights the myriad of other issues that also need to be considered when dealing with debts. Under the current circumstances there may be a variety of ways in which the terms of debt arrangements can be altered. Contemporary tax advice should always be sought.

Some questions that arise include:

  • Could commercial adjustments to the terms of the debt change the instrument from a tax law debt to tax law equity (resulting in a fundamental change to the taxation of that instrument)? Could, for example, extending the term of the instrument beyond a 10 year period with an insufficient rate of interest, result in changing the tax character from a debt instrument to an equity instrument?
  • Can the deferral occur for parts of a debt (such as a particular tranche) but not for other parts of that debt?
  • How will the lender be treated in the case of any suspended interest? If for example the counterparty is a financial institution, does the loan becomes a non-accrual loan for the purposes of TR 94/32 or will there will be implications under the taxation of financial arrangements provisions in Division 230?
  • Is there is any difference in how interest is treated during a period of deferral? In particular, if interest is capitalised is that interest still assessable to the creditor but not be subject to withholding tax?

Observations

Given the adverse economic impacts of COVID-19 the ATO announcement is relevant given the increasing numbers of businesses likely to seek the deferral of their debt repayment obligations.

Businesses may also need to consider the flow on consequences where there is a suspension or deferral of a loan. Lenders, for example, may be required to impair their assets, which could have adverse thin capitalisation implications.

To fully explore the impact and implications this announcement has on your business, reach out to a member of our Tax team.

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https://www.minterellison.com/articles/ato-confirms-loans-put-on-hold-during-covid-19-are-not-subject-to-debt-forgiveness

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