Question

The client (a private company) has a loan from a shareholder (an individual). The shareholder wishes to forgive part of the loan owing from the company. What are the tax implications for the company and the shareholder, if any? No interest has been charged or paid on the loan.

Answer

If the shareholders waive or forgive the loans owed to them by the company there may be tax implications for both the shareholders and the company. The waiver of the loan would trigger the commercial debt forgiveness rules for the company and may give rise to a capital loss in the hands of the shareholders. In broad terms, the debt forgiveness rules operate in order to reduce deductible amounts in the hands of the company.

Company

The forgiven amount is applied to the extent possible against relevant reducible amounts of the company. The reducible amounts are, in order:

• prior year tax losses, 
• prior year capital losses, 
• deductible amounts (eg, WDV of depreciating assets) 
• and the cost base of certain CGT assets.

Shareholder

A capital loss may potentially result for the shareholders in respect of the forgiveness of the outstanding loan balance. However, it is necessary to show that: 

• A CGT event has been triggered (a deed of release or similar document would assist in formalising the forgiveness or waiver of the loan); 
• The company’s ability to repay the loan has diminished since the loans were made; and 
• The loan is not a personal use asset of the shareholder. Section 108-20 ITAA 1997 provides the definition of a personal use asset which includes a debt arising other than in the course of gaining or producing assessable income or from carrying on a business.

Where the loan was on an interest-free basis there is a risk that the loan would be treated as personal use assets and any capital loss would not be available. As the creditor is the shareholder of the company it may be possible to argue that the loan was made to generate future assessable dividends from the company, although this would need to have been a realistic and genuine expectation at the time the loan was made.