The surge in Small Business Restructuring (SBR) appointments in Australia has been primarily driven by the Australian Taxation Office's (ATO) efforts to recover its expanded $60+ billion debt following the economic challenges posed by COVID-19.
The ATO is increasingly employing its firmer debt recovery actions, including director penalty notices (DPN), to compel directors to address tax debts by appointing a liquidator to wind down the company or appointing external administrators, including SBR Practitioners for eligible businesses, to allow business to continue trading and provide a better return.
Notably, creditors, particularly the ATO, have, in some cases, agreed to write off up to 90% of the debt.
This article provides insights into the various tax considerations associated with an SBR appointment.
Outstanding Tax Lodgements
Before a restructuring plan can be put to creditors, the ATO generally requires:
- All Activity Statements, including Business Activity Statements (BAS) and Instalment Activity Statements (IAS) to be lodged up to and including the date of the SBR appointment. This will include an Activity Statement covering the partial period from the end of the last reporting period to the date of the SBR appointment.
- All prior years Income Tax Returns (ITR) to be lodged include a ITR for the current financial year up to the SBR appointment date.
Following the SBR appointment, the ATO establishes a new account for the Company, known as a Client Activity Centre (CAC or Branch number), to differentiate between pre and post SBR appointment debts, so as future obligations of the company following the appointment can be met.
Implications of Related Party Debt Forgiveness
In contrast to a Deed of Company Arrangement (DOCA), there is no ability for related party creditors to subordinate their debt to allow for a higher return to unrelated creditors within the SBR.
As an alternative, related parties may consider forgiving their debt owed by the company prior to commencing the SBR process and appointing a Restructuring Practitioner in order to maximise the returns under the Restructuring Plan.
This may, however, trigger a deemed dividend under Division 7A for the related entity forgiving the debt, and appropriate advice should be obtained prior to forgiving the debt.
What is the tax treatment for the debt compromised/written off from a successful SBR
Once the funds that were required to be contributed to the Restructuring Practitioner under the Plan have been distributed in accordance with the Plan, the company is released from all admissible debts or claims that existed as at the date of the commencement of the SBR process. It is understood that the debt written off under the restructuring plan is classified as non-assessable non-exempt (NANE) income, and therefore, it is not included in the income tax return, resulting in no tax liability on the forgiven amounts.
For the creditor forgiving the portion of debt not paid through the SBR, debt forgiveness rules may apply, typically leading to a revenue loss (or, in some instances, a capital loss).
Treatment of Carried-Forward Tax Losses Post-Restructuring Plan
Upon completion of the restructuring plan, where the debts have been written off, commercial debt forgiveness rules may be applicable. In such cases, the net-forgiven amount must be used to reduce various tax balances in the specified order, including:
- tax losses
- net capital losses
- certain undeducted revenue or capital expenditures
- cost bases of certain Capital Gains Tax (CGT) assets.
However, if both the company under SBR and the creditor are under common ownership, the company's net forgiven amount can be reduced to the extent that the related party creditor agrees to forgo their revenue deduction or capital loss resulting from the debt forgiveness.
It's important to note that the commercial debt forgiveness rules do not extend to tax-related debt. Hence, a company's carried-forward tax losses (or any other 'tax balances') remain unaffected when tax-related debt owed to the ATO is partially reduced upon the completion of the restructuring plan.
SBR and permanent discharge of tax debt
A significant advantage of undertaking a SBR is the formal and permanent discharge of tax debt under an approved restructuring plan. There is a moratorium on creditor claims as at the date of the commencement of the SBR, meaning interest and penalties on ATO debt are frozen, and remain frozen until the Restructuring plan ends.
In contrast, an informal agreement with the ATO may result in the debt being considered as 'not economical to pursue' and collection activity may resume at any future point in time, at which time interest and penalties will be applied.
It's essential to recognize that the ATO may choose to resume debt recovery efforts if public interest considerations support such action, especially in cases involving a history of non-compliance by taxpayers.
Please bear in mind that the information provided here is for general reference only, and each company's circumstances are unique. Tailored tax advice is recommended, addressing the specific situation. In the appropriate circumstances, it is advisable to seek formal taxation advice that outlines the proposed strategy and intended actions.