Robert Richards looks at the circumstances where a debt could be forgiven; and a taxpayer loses out when the court rules that work experience expenses are not deductible.
Forgiveness is not a divine right
Tax planners would love to identify devices which would allow a person to claim a tax deduction but which did not also involve economic cost.
This is what many of the recent Western Australian agriculture tax shelter schemes were about. By and large these schemes have been unsuccessful. They have involved taxpayers, by way of limited recourse debts and round robins, purportedly making contributions to agricultural businesses. However, the ATO has been successful in showing that Part IVA of the Income Tax Assessment Act 1936 denied those taxpayers the deductions sought (see for example Calder v FC of T, Full Federal Court, 7 December 2005).
Another example of taxpayers seeking tax deductions is where a person (who must be self-employed) makes a tax deductible contribution into a superannuation scheme for that person's own benefit.
In this case, however, the tax law specifically encourages taxpayers to claim deductions for contributions which effectively have no economic cost. (It's no wonder superannuation has become the preferred tax planning option of many taxpayers, the combination of tax deductible contributions which in due course can be recouped tax free once the taxpayer turns 60, and ATO approval is a combination irresistible to many.)
Tax law (at section 8-1 of the Income Tax Assessment Act 1997) allows a deduction for losses and outgoings incurred, it is the incurrence of a loss or outgoing which causes the deduction. This section is not concerned with the actual payment of that loss or outgoing.
In the absence of any provision to the contrary, this section provides tax planning opportunities to a taxpayer. For example, a loss or outgoing could be incurred and no actual payment ever made for it. While section 82KK of the Income Tax Assessment Act 1936 would prevent the more blatant of such schemes, there are limits to that section and it could be easily avoided by use of the bad debt provisions.
However, the tax law does contain other provisions designed to limit the availability of tax deductions where a person has not suffered the commercial costs of incurring a loss or outgoing. These provisions are contained within Division 245 of Schedule 2C of the Income Tax Assessment Act 1936. They are the so called 'commercial debt forgiveness provisions'.
If a commercial debt is forgiven, the amount of the debt forgiven reduces, in order, prior year revenue losses, prior year net capital losses, undeducted balances of other expenditure being carried forward for deduction (which includes expenditure on depreciable assets) and the capital gains tax cost base of other assets held by the taxpayer.
A commercial debt is one on which interest is deductible or would be but for some specific exclusion (not being an exclusion which prevents deductions for capital, private or domestic out-goings or for outgoings relating to exempt income) or would be deductible were interest to be charged on the debt.
A forgiveness occurs if the obligation to repay the debt is waived, the right to recover the debt ceases because of a statute of limitations, the debt is assigned to an associate of the debtor, or the debt is 'parked'. The rules do not apply if the debt is forgiven under bankruptcy law, by a will, or for reason of natural love and affection.
The decision in Tasman Group Services Pty Ltd v FC of T (Federal Court, 29 January 2008) appears to have been a failed attempt by an applicant to escape those provisions.
The applicant was at one time owned by Sumikin Bussan Corporation Limited (SBC) a Japanese corporation.
The applicant purchased a meat processing and exporting business formerly owned and operated by what was described as the Gilbertson group.
The acquisition was funded in part by allotment of share capital and partly by loan from SBC. The business was unsuccessful and incurred substantial losses.
As a consequence of these losses SBC made further loans to the applicant. Also SBC agreed to extend the time for repayment of the earlier loans and later it agreed on a number of occasions to extend the time of repayment of all loans made by it to the applicant.
SBC later sold all of its shares in the applicant. It would appear that as part of the sale SBC agreed that it would not require repayment by the applicant of any of the amounts owed by the applicant to it.
In subsequent assessments the ATO assessed the applicant on the basis that the 'commercial loan forgiveness provisions' applied to it. (It is not apparent from the judgement how it applied those provisions.)
The applicant sought to avoid the operation of the provisions. It tried to do this by arguing that none of the requirements of the commercial debt forgiveness provisions had been satisfied.
So first it argued that there was no debt. It said that the loan agreements were as a consequence of the sale of the shares unenforceable since SBC would have breached covenants it had given had it sought repayment of the debts owing to it. (SBC had agreed to delay seeking repayment of the debts to support the solvency of the applicant.)
However, the court concluded here: 'The short answer is that there is still an enforceable obligation imposed by law to pay a creditor even if the time for payment is postponed or deferred.' (I wonder what was the point of that argument, if the debts had become unenforceable by reason of those covenants, I would have thought that there would have been a commercial debt forgiveness as at the time of the giving of the covenants.)
The applicant then argued that there was not a 'commercial debt'. It argued that there was no intention that the debts be repaid. Therefore it said that the debts took on the character of an equity investment. As such they could not bear interest. It inferred that the fact the lender and borrower were a parent and wholly owned subsidiary altered the characterisation of the funding. It was effectively arguing, very oddly for a taxpayer, that all of its documentation was a sham.
However, the court also rejected this argument. It said 'The loan agreements, the variations thereof and the payments made thereunder were properly documented' and that there was no suggestion of sham.
Then the applicant argued that in any event there had not been 'forgiveness', the applicant argued that for the commercial debt forgiveness provisions to operate a debt had to be expressly forgiven and there was no evidence here that had been done so.
But the court said the commercial debt forgiveness provisions cannot be read down so as to require some express forgiveness, rather 'waiver' may be by conduct (it being an intentional act done with knowledge whereby a person abandons a right by acting in a manner inconsistent with that right). Does this case prove much? It obviously illustrates the commercial debt forgiveness provisions (and the dicta on informal waivers is important). But apart from that it if I had to categorise the value of the decision I would say it was simply a case where an aggressive taxpayer sought to argue that a law was not applicable by the textbook method of disputing each and every technical point.
Vocational work denied deduction
It is not uncommon for vocational courses to consist both of a formal segment and a compulsory practical experience segment. Indeed this is most probably the basis of traditional trade apprenticeships.
This also appears to be common with hospitality courses, students have to attend formal courses and then work in hotels (and guests are supposed to smile while paying for students to act like Basil Fawlty while they stay at the hotel, as happened to me once at a hotel in Canberra).
The decision in Cheung v FC of T (Administrative Appeals Tribunal, 19 March 2008) was a case where a student at a hotel school sought to offset the fees paid by her in attending the school against income derived by her while earning her practical work experience. However, the Tribunal denied the deduction sought by the taxpayer. While it was a condition of attendance at the school that the taxpayer gain practical experience, her paying fees to the school did not cause her to derive income. The Tribunal said the mere fact that there was a connection between the course and the employment was insufficient. The fact that the derivation of assessable income was incidental to the course of self-education did not mean that the course of self-education was incidental to the derivation of assessable income.
Robert Richards CPA is a solicitor specialising in tax matters.
Clarification In the March issue, 'Taxing times' reported in the story, 'Departure Issues', that the taxpayer concerned paid all but $112,303 of a $5,616,712.30 debt. In fact, the judgement reported that the taxpayer had only paid $112,303 of the outstanding debt.
