How does ATO debt forgiveness work?

For most Australians, personal household debt is a prevalent issue that can cause stress and strife. As of 2022, 73% of Australian households were in debt in some form. This figure has remained largely the same since 2015.

Perhaps more worrying is that a quarter of these households had to contend with debt up to three times their yearly income, making the prospect of becoming debt free a distant one. And if debt continues to spiral and accumulate, as can often happen, individuals and businesses may find themselves unable to pay off debt.

That is where commercial debt forgiveness rules enter the picture, a notion that, in theory, can provide a solution for many. 

Let’s answer the following commonly asked questions:

  • What is debt forgiveness?
  • Will the ATO forgive a debt?
  • When can debt be forgiven?
  • How is commercial debt forgiveness calculated?
  • Are there exclusions to debt forgiveness provisions?
  • How are bankruptcy and debt forgiveness different?
  • What is the ATO Tax Determination?
  • Are there any alternative debt solutions?

Q1. What is debt forgiveness?

People go into debt for reasons that vary, and it can impact all aspects of finances, from individual tax losses and business net capital losses to superannuation SMSF, and of course, their lifestyle in general. One of the ways in which they may find reprieve, however, is through debt forgiveness.

Debt forgiveness is when a creditor cancels a part of or all of a person or business’s outstanding bad debts that they cannot feasibly repay through regular means.

However, that is not to say that the issue is completely settled once a creditor has agreed to the debt forgiven amount. Often only a portion of the debt is wiped, meaning you will still be required to pay some of it back. 

Tax consequences may be attached to subsequent income, and any form of debt forgiveness is likely to harm credit scores.

Q2. Will the ATO forgive a debt?

The Australian Taxation Office (ATO) is only permitted to work within the boundaries and remits set by Parliament regarding tax legislation. As a result, while it is possible to gain some form of tax amendment or relief through negotiation with the ATO, it is a complex and lengthy process.

For example, several factors will affect the decision if you wish to be released from certain tax debts via the ATO. These include your spending history and whether it has been responsible, your other debt commitments and how well you manage them, and hardship considerations.

There are exceptional circumstances where the ATO may be able to compromise debts. However, the number of stipulations and regulations must be considered and adhered to before such a decision is extensive.

You can find a full list of these requirements on the ATO’s official practice statement. It should also be noted that once an ATO decision has been made, it is non-negotiable.

Q3. When can debt be forgiven?

A few circumstances may result in debt forgiveness being a feasible option. Debt may be forgiven for reasons such as if the creditor’s obligation to pay the debt is waived or released, they will no longer be required to press the debtor so stringently for repayment.

The creditor can also enter into an alternative arrangement with the debtor. This could take the form of a new amount that needs to be repaid, or your creditor could impose a time limit to pay off as much as possible. If ‘debt parking’ occurs on behalf of the creditor, then the debtor’s obligations could become void.

Q4. How is commercial debt forgiveness calculated?

The total amount of debt forgiveness takes several figures into account during calculation, including the debtor's income. 

The gross forgiven amount is used as the starting figure. From that figure, you can deduct any amounts included in assessable income, reductions in allowable deductions, and reductions in cost bases of capital gains tax (CGT) assets.

This figure is known as the net forgiven amount. You can search online for calculators and tools to help or contact a tax professional for details.

Q5. Are there exclusions to debt forgiveness provisions?

There are occasions when debt forgiveness is not subject to such a stringent set of requirements. For example, if the debt can be seen in respect of employment, the debt will often be forgiven or reorganised into a fringe benefits tax.

There may also be circumstances where a debt can be forgiven through bankruptcy. 

There are also situations where the debt is forgiven if it is affected by a last will and testimony or, in the case of more familial debts, it may be written off for reasons of natural love.

Q6. What is the ATO Taxation Determination TD?

In February 2022, new rules came into effect with the release of a draft Taxation Determination change. 

Under Section 245 of the Income Tax Assessment Act 1997 (Cth), when a creditor forgives a debt, the amount is subtracted from other amounts that could lower taxable income.

Paragraph 245-40(e) says that these offset rules apply to a debt that is not forgiven out of natural love and affection.

For paragraphs 225-40(e), the Commissioner of Taxation has now decided that the creditor who forgives the debt must be a natural person.

This decision will make it harder for people to get their debts forgiven, so they may have to look for other ways to do it.

Q7. How are bankruptcy and debt forgiveness different?

Both bankruptcy and the act of being forgiven debt serve the same purpose to help an individual or company get out of debt as quickly as possible. However, there are a few notable differences.

To be declared bankrupt, an individual must undergo a federal court procedure. Debt forgiveness can be settled directly with a creditor.

Bankruptcy is the more direct route out of debt, but the long-term consequences are often far more severe than with debt settlement. It will remain on credit reports for 7-10 years which will make securing additional forms of ‘good’ debt, such as a mortgage, very difficult.

Bankruptcy is usually seen as the last resort when all routes related to debt forgiveness have been explored and ruled out.

Q8. Are there any alternative debt solutions?

As well as debt forgiveness and bankruptcy, a handful of other solutions could be utilised to get a person out of debt.

There may be the option to refinance any existing loan commitments. This doesn’t eliminate the debt but will often lead to lower interest rates or more manageable monthly payments over an extended period. 

You could also take out a consolidation loan which will pay off all existing debts and leave you with a single monthly repayment to concentrate on.

Summing up

Depending on your repayment history, you may also be able to temporarily defer payments if you suddenly find yourself experiencing temporary hardships or a change in circumstances. This can often give you the time to figure out your next steps.

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Disclaimer: The author is not a financial advisor and the information provided is general in nature and was prepared for information purposes only. This article should not be considered to constitute financial advice. Accordingly, reliance should not be placed on this article as the basis for making an investment, foreign investment, financial or other decision. This information does not take into account your investment objectives, particular needs, or financial situation.

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