Forgiving a debt – CGT may not be so forgiving

In practice we often see concessions made and compromises entered into in respect of debts owing to a person. Whatever the reason for forgiving a debt may be, consideration should always be given to the potential capital gains tax (CGT) implications. This article touches on some of the issues.

Introduction

The CGT rules dealing with debt concessions and compromises are aimed at ensuring that the true capital gain or capital loss is determined where assets have been financed with loans and the loans are subsequently forgiven.

In reality the taxpayer would under the above circumstances not have incurred any commercial cost or cash outlay to acquire impacted assets.

If a debt is forgiven under the above circumstances, a “debt benefit” is regarded as having accrued to the taxpayer. The benefit is linked to the costs incurred with the original loan finance to determine the CGT treatment thereof.

Let’s explore this a little further …

Impacted assets still in the taxpayer’s possession

If an asset financed by the forgiven loan is still in possession of the taxpayer at the time that the loan is forgiven, the base cost of the asset (i.e. the value of the asset for CGT purposes) is reduced by the amount of the debt forgiven.

When the impacted asset is actually disposed of in the future, the reduced base cost of the asset will result in a higher capital gain, effectively taxing the debt benefit at that time.

So good so far …

Impacted assets no longer in the taxpayer’s possession

Where impacted assets have already been disposed of in a previous year of assessment and the capital gain or loss was declared in the relevant year of assessment, the gain or loss originally computed must be re-computed taking the debt benefit into account.

The good news is that the re-computed capital gain or loss is treated as a capital gain in the year of assessment that the debt benefit accrues to the taxpayer. It is therefore not necessary to re-open past assessments.

Any way out?

They are various instances where a debt benefit is excluded from the CGT net. Examples include where the debt is inherited from a person in terms of a will, where donations tax is payable, fringe benefit tax is payable on a debt written off, certain transactions within a group of companies, etc.

Some of the exclusions are quite technical in nature and care should be taken to ensure that the exception applies before an unnecessary CGT liability is incurred.

Summary

In future articles we’ll continue exploring some of the specific applications of CGT in practice.

This article provides a birds eye view of the rules governing debt concession and compromise arrangements. In practice some of the rules are quite complex and advice always be sought before decisions are made in this regard.