2 ASIA-PACIFIC TAX BULLETIN
AUSTRALIA
Tax Treatment of Debt-for-Equity Swaps
By Nabil (Bill) Orow
Nabil (Bill) Orow is Director of the Graduate Tax
Program at Monash University; e-mail:
Nabil.Orow@BusEco.monash.edu.au. Mr Orow is a
member of the Law Institute of Victoria Revenue
Committee. He is also a Consultant to KPMG
Melbourne.
I. INTRODUCTORY COMMENTS
In circumstances where a debtor (borrower) is unable to
repay or service an existing debt, the creditor (lender) has
a number of alternative courses of action available includ-
ing foreclosure or liquidation. As an alternative to such
drastic measures, the parties may enter into an arrange-
ment whereby, in consideration of the debtor issuing
equity to the creditor, the outstanding debt is extinguished.
A debt-for-equity swap occurs when a creditor agrees with
a debtor to discharge, release or otherwise extinguish a
debt in return for equity in the form of shares or units in
the debtor. In this sense, the parties agree to swap the out-
standing debt in exchange for equity in the debtor. The
equity would be the property of the creditor and is not a
mere security for the debt which would be extinguished. It
follows that under the swap arrangement, the debt is in
form and substance “swapped” into equity.
The creditor is most likely to enter into such an arrange-
ment where the debtor is technically insolvent and may be
required, under the debt instrument or by law, to cease
trading and liquidate its assets to discharge the debt to the
extent of the value of the assets. In generally depressed
economic conditions, it may be a better option for the
creditor to participate in equity than to foreclose against
the debtor. The decision may be that the only real prospect
of recovering the amount of the debt owed is by way of
equity participation in the debtor’s business over a longer
period.
Debt-for-equity swaps more commonly take place in
respect of borrowings, although it is possible for trade
creditors and debtors to enter into such arrangements.
Prior to the introduction of Section 63E1 of the Income Tax
Assessment Act 1936 (the “ITAA 1936”), which is the
existing provision directed at debt-for-equity swaps, such
arrangements were dealt with under the ordinary provi-
sions dealing with general deductions and bad debts as
contained in Sections 51(1) and 63(1)2 ITAA 1936.3
© 1999 IBFD Publications BV
JANUARY 1999
II. SUMMARY OF THE OPERATION OF SECTION
63E
Section 63E(3)(a) ITAA 1936 is a specific provision that
allows a deduction for debt written off after 26 February
1992 as part of a debt-for-equity swap arrangement with a
debtor.
For the purposes of Section 63E, the amount of the
deductible loss is:
A–B
where:
A = the book value of the debt extinguished
B = the value of the equity received in return for extinguishing
the debt; the value of the equity is the greater of:
– the market value; or
– the value recorded in the books of the creditor
The loss deduction is reduced to the extent that it has pre-
viously been allowed as a deduction under the ITAA 1936
or 1997.
Profits or losses subsequently realized on the disposal,
cancellation or redemption of the equity are, depending on
the circumstances, either included in assessable income or
allowed as deductions. Where the conditions of Section
63E are satisfied, a deduction will be allowable in respect
of a loss incurred under a debt-for-equity swap notwith-
standing that the debt, or a part of the debt, is not tech-
nically a bad debt in the sense of being commercially or
legally irrecoverable.
III. TAXATION OF DEBT-FOR-EQUITY SWAPS
BEFORE 27 FEBRUARY 1992
Prior to the introduction of Section 63E, debt-for-equity
swaps were dealt with under the ordinary provisions deal-
ing with general deductions and bad debts as contained in
Sections 51(1) and 63(1) ITAA 1936.
A. Conditions for the operation of Section 63
Section 63 ITAA 1936,4 allows a deduction for bad debts
written off in relation to interest, trade debts and other
charges, which have been brought to account as assessable
1. Infra II., IV.
2. Infra III.
3. Corresponding Sections 8-1 and 25-35 of the Income Tax Assessment Act
1997 (the “ITAA 1997”).
4. Corresponding to Sec. 25-35 ITAA 1997.
JANUARY 1999 ASIA-PACIFIC TAX BULLETIN
income. For taxpayers who carry on a business of money
lending, the writing-off of bad debts on loans made in the
ordinary course of business are deductible under the gen-
eral deduction provision whether or not the amounts writ-
ten off have been included in assessable income.5
1. Is there a debt?
In order to obtain a bad debt deduction under Section 63,
there must be a debt in existence before it can be written
off as “bad”. A debt exists for the purposes of Section 63
where a taxpayer is entitled to receive a sum of money
from another either at law or in equity. A debt creates a
relationship between the lender and borrower which
imposes an obligation on the borrower to make regular
payment of interest on the outstanding loan amount.
The common meaning of “interest” refers to money which
accrues from day to day, calculated according to a fixed
ratio of a sum lent, that is agreed to be paid under a con-
tract of loan.6 In this sense, interest is referable to a princi-
pal in money or an obligation to pay money. Although the
obligation to pay interest is ordinarily periodic, the fact
that a lump sum is paid does not preclude it from being
characterized as interest provided it satisfies this definition
of interest.
2. Has the debt gone “bad”?
The debt must have gone “bad” in the relevant sense. The
question of whether the debt is bad is a matter of commer-
cial judgement having regard to all the relevant facts. Gen-
erally, for the purposes of the section, the test of when a
debt is bad is a pragmatic commercial one and it is not ne-
cessary for the debt to be absolutely or legally irrecover-
able. A debt is regarded as bad when a reasonable com-
mercial person would consider it unlikely that the debt will
be repaid.
In Taxation Ruling TR 92/18, the Commissioner indicated
that a debt may be considered to have become bad in any
one of the following circumstances:
– the debtor has died leaving no, or insufficient, assets
out of which the debt may be satisfied;
– the debtor cannot be traced and the creditor has been
unable to ascertain the existence of, or whereabouts of,
any assets against which action could be taken;
– where the debt has become statute barred and the
debtor is relying on this defence (or it is reasonable to
assume that the debtor will do so) for non-payment;
– if the debtor is a company, it is in liquidation or
receivership and there are insufficient funds to pay the
whole debt, or the part claimed as a bad debt; or
– where, on an objective view of all the facts or on the
probabilities existing at the time the debt, or a part of
the debt, is alleged to have become bad, there is little
or no likelihood of the debt, or the part of the debt,
being recovered.
The final situation above expresses the principles too
strictly. It is submitted that in circumstances where there is
no reasonable prospect of recovery, from a commercial
point of view, then the debt is bad in the statutory sense.
© 1999 IBFD Publications BV
3
3. Has the debt been “written off” as bad before
year’s end?
The bad debt, or part of the debt, must be written off in the
year of income before a bad debt deduction is allowable
under Section 63. To that end, highly technical accounting
entries are not necessary. It is sufficient that some form of
written record is kept to evidence the decision to write off
the debt from the accounts before year-end.
In Case 33,7 the Taxation Board of Review expressed the
view that the writing off of a bad debt does not necessitate
a particular form of book entry or even a book entry at all.
It is sufficient if there is something in writing which in-
dicates that the creditor has treated the debt as bad. In this
sense, there is a requirement that the debt has to be phys-
ically written off.
This condition may not be satisfied where, in the relevant
financial/taxation year, there is no evidence whatsoever
that anything was put in writing from which it could be
gathered that the taxpayer intended to treat the debt as bad.
This places the burden upon any taxpayer who seeks to
obtain the benefit of the section to provide sufficient
evidence to prove that there was a physical writing off of
the debt in the year of income.8
In Taxation Ruling TR 92/18, the Commissioner indicated
that the requirements of Section 63 may be satisfied even
though a debt is not written off in the books of account.
For example, Section 63 will still be satisfied in circum-
stances where:
– a board meeting authorizes the writing off of a debt
and there is a physical recording of the written partic-
ulars of the debt and board’s decision prior to year-end
but the writing off of the debt in the taxpayer’s books
of account occurs subsequent to year-end; or
– a written recommendation by the financial controller
to write off a debt which is agreed to by the managing
director in writing prior to year end followed by a
physical writing off in the books of account subse-
quent to year-end.
4. Has the debt been brought to account as assessable
income or is it in respect of the business of money
lending?
The debt must either have been brought to account as
assessable income or have been in respect of loans made in
the ordinary course of business of money lending. This
requirement presupposes a non-cash basis of returning
income for tax purposes. Taxpayers who operate and lodge
returns of income on a cash receipts basis are not entitled
to a deduction for bad debts: because the outstanding
amount has not been received, it has never been included
in their assessable income.
5. See also Secs. 25-35(1)(a) and (b) ITAA 1997.
6. FCT v. Radilo Enterprises Ltd (1997) 97 ATC 4151.
7. (1941) 10 TBRD 101, at 103.
8. Case 28 (1947) 13 TBRD 223, at 239.
4 ASIA-PACIFIC TAX BULLETIN
B. Deduction under Section 51(1)
Where a deduction for a bad debt is not allowable under
Section 63, it may nevertheless be allowable under Section
51. Section 51(1) allows a deduction for losses and outgo-
ings to the extent that:
– they are incurred in gaining and producing assessable
income; and
– they are not of a capital or private nature.
In AGC (Advances) Ltd v. FCT,9 the High Court of Aus-
tralia, by a majority held that the taxpayer was entitled to a
deduction under Section 51(1) for the amount of written-
off debts relating to principal instalments to the extent that
they were owing at the time they were written off. Simil-
arly, in Marshall and Brougham Pty Ltd v. FCT,10 Jacobs J.
expressed the view that a loss being a bad debt which may
not be an allowable deduction under Section 63(1) may
nevertheless be an allowable deduction under Section
51(1). This view was endorsed on appeal by the Full Fed-
eral Court.11
The two principal considerations for the purposes of swap
loss deductions under Section 51(1) ITAA 1936 and its
successor Section 8-1 ITAA 1997 relate to:
– whether the bad debt occasioned by the swap loss has
been “incurred”; and
– whether it is of a “capital nature”.
It is unclear whether the act of writing off, which is neces-
sary under Section 63, is necessary for a debt to be
incurred within Section 51(1). In Taxation Ruling TR
92/18, the Commissioner expressed the view that a bad
debt deduction is allowable under Section 51(1) when it is
written off and suggested that this view is supported by a
number of judicial comments to that effect. In AGC
Advances,12 Mason J. indicated that a loss constituted by
the writing off of a bad debt is incurred, in the sense that it
is sustained, at the time when the debt is written off. His
Honour added that the loss may be said to be one which
was incurred in the carrying on of a business notwith-
standing that its true character as a loss is not finally ascer-
tained until the debt is written off.
The views of Mason J. merely confirm that the act of writ-
ing off is sufficient to satisfy the requirement that a loss
has been incurred. The comments referred to do not pre-
clude the proposition that a swap loss may be incurred for
the purposes of Section 51(1) notwithstanding the it has
not been written off. That occurs at the time when the debt
is:
– disposed of;
– settled;
– compromised; or
– otherwise extinguished.
C. Examples
The following examples illustrate the application of Sec-
tion 63 to debt-for-equity swaps carried out before 27
February 1992.13
© 1999 IBFD Publications BV
JANUARY 1999
Example 1
A financial institution has a debt of AUD 150, none of which has
been written off as a bad debt. The institution and the borrower
agree to enter into a debt-for-equity swap arrangement whereby
AUD 100 of the debt is to be applied in issuing the institution
with 100 shares, with a par value of AUD 1 each,14 in the bor-
rower. These shares have a market value of AUD 25 at the time
of the swap. The remaining AUD 50 of debt, which is not
involved in the debt-for-equity swap, is clearly a bad debt.
The tax treatment of the institution is as follows:
(1) AUD 50 can be written off as a bad debt and a deduction
claimed under Section 63(1)(b).
(2) A further deduction would be allowable under Section
63(1)(b) for AUD 75 (being the difference between the
amount of the debt involved in the debt-for-equity swap and
the market value of the equity obtained in the swap) if the
debt was written off as bad prior to the discharge of the debt
under the debt-for-equity swap agreement.
(3) For the purposes of determining whether a gain or loss is
made on the subsequent disposal of the shares, the shares
will have a cost of AUD 25.
Example 2
A financial institution has a debt of AUD 150 which has been
written off as bad and in respect of which a deduction has been
allowed under Section 63. Subsequently, the institution and the
borrower enter into a debt-for-equity swap agreement whereby
AUD 100 of the debt is applied in issuing the institution with 100
shares, with a par value of AUD 1 each, in the borrower. These
shares have a market value of AUD 25 at the time of the swap.
In this case, the tax treatment of the institution is:
(1) AUD 25 will be included in the institution’s assessable
income pursuant to Section 63(3). The market value of the
shares (AUD 25) received in the debt-for-equity swap is a
recovery in respect of a debt for the purposes of Section
63(3).
(2) The shares will have a cost of AUD 25.
In circumstances where a bad debt deduction is not allowable
under Section 63(1), a deduction may be allowable under Sec-
tion 51(1) for the loss arising out of a debt-for-equity swap. The
availability of a deduction in these circumstances depends
upon considerations such as:
– the nature of the taxpayer’s business; and
– the degree of connection between the loss and the activities
of the taxpayer which are productive of assessable income.
IV. TAXATION OF DEBT-FOR-EQUITY SWAPS
ON OR AFTER 27 FEBRUARY 1992
Section 63E provides a deduction for swap losses in
respect of debts extinguished in debt-for-equity swaps that
occur after 26 February 1992. Further, Section 63E
includes in assessable income profits or allows a deduc-
tion for losses realized from the future sale, redemption or
cancellation of the equity acquired in exchange for the
debt.
9. (1975) 75 ATC 4057, per Barwick CJ. and Mason J.; Gibbs J. dissenting.
10. (1986) 86 ATC 4469, at 4474.
11. FCT v. Marshall and Brougham Pty Ltd (1987) 87 ATC 4522.
12. AGC (Advances) Ltd v. FCT (1975) 75 ATC 4057, at 4071-4072.
13. These examples are taken from Taxation Ruling TR 92/18.
14. Note that the concept of par value has been removed from Australian Cor-
porations and Taxation law effective from July 1998.
JANUARY 1999 ASIA-PACIFIC TAX BULLETIN
There are two significant aspects to the operation of Sec-
tion 63E:
(1) The swap loss under Section 63E is not limited to the
bad part, if there is one, of the debt swapped. In this
sense, Section 63E provides deductions that would not
be available under the general deduction provision in
Section 8-1 ITAA 1997.
(2) Profits realized or losses incurred on the subsequent
disposal, cancellation or redemption of the equity are
included in assessable income or allowed as deduc-
tions as the case requires. This is consistent with the
broad purpose and policy of the section because the
relevant swapped equity was received in exchange for
a revenue item; accordingly, that equity should be
dealt with as a revenue matter.
A. Conditions for the operation of Section 63E
Section 63E(1) specifies the necessary conditions that
must be satisfied for a debt-for-equity swap to occur.
These conditions are:
– there is an arrangement15 under which the taxpayer
extinguishes a debt or part of a debt owed to the tax-
payer in return for the debtor issuing shares (other than
redeemable preference shares) or units in the debtor;
– the debtor in question is a company, a trading trust16 or
a public unit trust17 in relation to the year of income in
which the units are issued;18 and
– either:
– the debt has been included in or brought to account
by the taxpayer as assessable income of any year
of income;
or:
– is in respect of money lent by the taxpayer in the
ordinary course of a money lending business.19
B. Deduction for swap loss
Section 63E(3) authorizes deductions for losses incurred
under debt-for-equity swap arrangements. The deduction
is allowable in the year of income in which shares or units
are issued in return for the debt being extinguished.
Where a deduction is allowed under Section 63E, the debt
or part of the debt extinguished, in connection with the
debt-for-equity swap, may not be treated as a bad debt
deduction allowable under Sections 8-1 or 25-35.20 This
prevents double deductions from being claimed. Where:
– a taxpayer receives shares or units under a debt-for-
equity swap; and
– the taxpayer is required to include an amount in
assessable income under Section 63(3) or Subdivision
20A ITAA 1997 to recoup deductions previously
allowed in relation to the debt under Sections 8-1 or
25-35.
The amount received in respect of the issue is taken to be
the same as the “equity value” of the shares or units.
Section 63E(2) deals with the meaning of “equity value”
and “swap loss”. A swap loss occurs if the amount of the
whole or part of the debt that is extinguished is greater
than the “equity value” of the shares or units that are
© 1999 IBFD Publications BV
5
exchanged in the swap arrangement. In this respect, the
term “equity value” is critical to the operation of the sec-
tion because it is a necessary component in calculating the
amount of a deductible loss incurred under a swap. The
equity value for that purpose is the greater of:
– the market value of the shares or units acquired under
the swap at the time of their issue to the taxpayer; and
– their value shown in the taxpayer’s accounts at the
time they are issued to the taxpayer.
Where the amount of debt that is extinguished is greater
than the equity value, the difference is a “swap loss”
within Section 63E(2)(b) and hence is deductible.
As the creditor and debtor have at this stage fixed a def-
inite loss by the terms of the swap arrangement, the loss on
the swap is definite even though there may be no pre-exist-
ing bad debt.
C. Disposal of equity by the taxpayer following the
swap
Section 63E(4) governs the taxation consequences to the
taxpayer on the subsequent disposal of the equity received
in a debt-for-equity swap. Under Section 63E(4), profits or
losses realized on the subsequent disposal, cancellation or
redemption of equity acquired in a debt-for-equity swap is
brought to account as assessable income or allowable
deductions as follows:
(1) If the consideration received or receivable in respect of
the disposal, cancellation or redemption of the equity
(shares or units) is greater than the equity value as
defined in Section 63E(2)(a), the excess is a profit
which is included in the assessable income of the tax-
payer in the year the shares or units are disposed of,
cancelled or redeemed.
(2) If the consideration received or receivable is less than
the equity value, the difference is a deductible loss.
Under Section 63E(5), where no consideration is received
or receivable by the taxpayer in respect of the disposal,
cancellation or redemption, then a consideration of a nil
amount or value is taken to have been received or receiv-
able.
Example21
Consider a debt-for-equity swap arrangement where 1,000
shares in a debtor company are issued to a creditor in exchange
for the creditor extinguishing a debt. The shares have an equity
value of AUD 100.
15. The word “arrangement” is defined in broad terms in Section 63E(6) to
mean any agreement, arrangement, understanding, promise, undertaking or
scheme, whether express or implied, and whether or not enforceable, or intended
to be enforceable, by legal proceedings.
16. Within the meaning of Sec. 102N ITAA 1936.
17. Within the meaning of Sec. 102P ITAA 1936.
18. These types of trusts are treated as companies for taxation purposes.
19. Where a creditor, that is not a money lender, extinguishes a debt that com-
prises a part that has previously been included in assessable income (such as
accumulated interest) and another part that is related to the principal (which is
non-assessable), then only the part of the debt that has been included in the
assessable income falls within the scope of Section 63E.
20. Former Secs. 51 and 63 respectively of the ITAA 1936.
21. This example was provided in the Explanatory Memorandum to illustrate
the operation of Sec. 63E.
6 ASIA-PACIFIC TAX BULLETIN JANUARY 1999

The creditor later sells 600 shares for AUD 40. At that time, the Section 63F(1) limits current deductions to the extent that
creditor incurs a loss of AUD 20, which is an allowable deduc- they do not exceed the limit computed under Section
tion. 63F(2). The current deductions refer to bad debts allow-
Some time later, the debtor company’s business has recovered able under Sections 8-1 or 25-35 as well as allowable swap
and the creditor sells the remaining 400 shares for AUD 430. losses under Section 63E(3).
The resultant profit of AUD 390 is included in the assessable
income of the creditor.
The requirements of Section 63F are specified in Section
63F(1) as follows:
The amount of the original swap loss does not limit this profit so (a) there is a current deduction that is allowable under
that any net profit is still a return that should be treated as hav- Sections 8-1, 25-35 or 63E for the whole or part of a
ing a revenue character, like the debt swapped. debt;
(b) a previous deduction was allowed or allowable under
AUD Sections 8-1 or 25-35 for the previous writing off of
the whole or part of a debt, or under Section 63E debt-
equity value of 1,000 shares 100 for-equity swap for a part of a debt (note that the
equity value of each share 0.10 “whole” could not have been swapped if (a) applies);
equity value of 600 shares 60 and
sold for 40 (c) the current deduction allowable or at least one previ-
net deductible loss 20 ous deduction allowed relates to swap loss deductions
equity value of 400 shares 0 under Section 63E.
sold for 430
net assessable profit 390 2. Calculation of limit
Section 63F(2) provides a step by step procedure to illus-
Note that an allowable swap loss deduction under Section 63E trate how to determine the limit. In effect, the limit is
(AUD 20 in the example) is subject to the limit determined under reduced:
Section 63F. – by deductions already given; and
– by repayments or other reductions in the debt.
D. Limit on swap loss deductions Under Section 63F(2), the limit is worked out as follows:
Step 1: Take the amount of the previous debt in respect
1. General
of the earliest or only writing off or debt-for-
equity swap to which paragraph (1)(b) applies.
Section 63E is expressed to be subject to Section 63F and Step 2: Reduce the amount by the previous deduction in
hence the swap loss deduction allowable under Section respect of that writing off or debt-for-equity
63E is limited by Section 63F. The purpose of Section 63F swap.
is to reduce an allowable swap loss deduction to the extent Step 3: If one or more of the following events occur after
that it has been previously allowed under: the writing off or debt-for-equity swap, progres-
– the general deduction provision in Section 8-1; sively reduce the balance of the amount in the
– the bad debt deduction provision in Section 25-35; or way set out below and in the order in which the
– Section 63E itself. events occur:
Section 63F seeks to ensure that at the end of discharging Event How balance reduced
the whole debt (either through one single debt-for-equity
swap, or a combination of debt-for-equity swaps, partial A writing off or debt-for- Reduce the balance by the
debt write-offs and repayments): equity swap in respect of amount of that previous
which there is a previous deduction. If the reduced
the net deduction allowed (that is the total amount of deduction. balance is higher than the
deductions allowed under Sections 8-1, 25-35 or 63E) level of the debt owing
less any amount recovered and assessed under subdi- after the event, further
vision 20A or Division 6 ITAA 199722 reduce the balance to that
should be equal to: lower level.
the initial amount of debt owing less the total sum of Any other event (such as a If the balance at the time
equity value or any other payments received in dis- repayment) that reduces of the event is higher than
charging the debt. the amount of debt owing, the level of the debt owing
being an event that occurs after the event occurs,
The operation of Section 63F may be illustrated by the fol- before the writing off or reduce the balance to that
lowing formula: debt-for-equity swap in lower level.
A = B – [C + D] respect of the current
deduction.
where:
A = net deduction The limit is the resulting balance.
B = initial amount of debt owing
C = equity value
D = any other payments
22. Former Secs. 63(3) and 25(1) respectively of the ITAA 1936.
© 1999 IBFD Publications BV
JANUARY 1999 ASIA-PACIFIC TAX BULLETIN 7

3. Example 400 for situation 2, but is limited to AUD 250 in situation

The following example contains representative scenarios 2A.
of debt-for-equity swaps. It shows the combined operation
of subdivision 20A ITAA 1997 and Sections 63E and 63F Situation 3
ITAA 1936.23 All the debt owing has been allowed as a bad debt deduc-
Assume that a taxpayer enters into a straightforward debt- tion before the swap. The limit under Section 63F(2) is nil
for-equity swap arrangement for the whole debt outstand- and no swap loss is allowable under Section 63E(3). The
ing. This is examined in three situations: equity value of AUD 200 is assessable under Subdivision
20A and Division 6.
Situation 1: No previous bad debt deduction has
been allowed under Sections 8-1 or
25-35 before the first debt-for- V. APPLICATION OF THE COMMERCIAL DEBT
equity swap. FORGIVENESS RULES
Situations 2 and 2A: A part of the debt has been written
off and allowed as a bad debt The commercial debt forgiveness rules, as contained in
deduction under Sections 8-1 and Division 245 ITAA 1936, were introduced with a view to
25-35 before the first debt-for- restoring balance in the tax treatment of debtors and cred-
equity swap. itors following the extinguishment of the debt.
Situation 3: All the debt has been written off as
bad and the full deduction has been The rules seek to claw back the tax benefit that a debtor
allowed under Sections 8-1 and 25- obtains when an outstanding debt is forgiven by creating
35 before the first debt-for-equity rules that apply the net amounts of debts forgiven in a year
swap. of income to reduce the debtor’s accumulated revenue
losses, net capital losses, certain undeducted expenditures
Situation Situation Situation Situation and cost bases of assets. In certain circumstances, the net
1 2 2A 3
forgiven amount of a debtor that is a company is appor-
tioned among companies related to the debtor company.
debt/equity swap
for the 600 600 600 600 Under existing Section 63E ITAA 1936, a debt-for-equity
whole debt (A) swap occurs where a creditor releases a debt or part of a
equity value (B) 200 200 200 200 debt in return for the issue of shares or units in the debtor.
bad debt deduction The release of the debt or part of the debt would constitute
allowed 0 200 350 600
forgiveness within Division 245.
Sec 63(3) income 0 200 200 200
The form of debt-for-equity swap covered by Section 245-
swap loss (A) – (B) 400 400 400 400 35(5) occurs where the creditor acquires shares in a debtor
Sec 63F(2) limit n/a 400 250 0 company so that the money paid to acquire the shares can
Sec 63E(3) be used by the debtor to discharge the debt or part of it. On
deduction 400 400 250 0 its face, the payment by the debtor appears to be nothing
more than a payment of the debt owing. However, Section
Situation 1 245-35(5) will treat:
The limit under Section 63F(2) does not apply because no – the debt as being forgiven to the extent it is paid out by
previous deduction has been allowed before the debt-for- this means; and
equity swap. The swap loss calculated under Section – the forgiveness to have occurred when the money the
63E(2)(b) for the purpose of Section 63E(3) will never creditor used to pay for the shares is applied to pay off
exceed the debt owing when entering into the debt-for- the debt.24
equity swap. The swap loss of AUD 400 is fully allowable
under Section 63E(3). The equity value of AUD 200 is not
assessed under subdivision 20A and Division 6 because no VI. CONCLUDING REMARKS
deductions for bad debts have been previously allowed.
Debt-for-equity swaps is a specific category of financial
Situations 2 and 2A transactions that does not sit well within the framework of
the ordinary provisions of the tax legislation. It is an area
A partial debt of AUD 200 and AUD 350 has been written that calls for a more specific tax treatment so as to promote
off before the swap. When the equity value of AUD 200 is certainty and clarity of law and principle. The proper
received under a debt-for-equity swap, the equity value is recognition, for tax purposes, of swap losses promotes
clawed back under Subdivision 20A and Division 6. The sound commercial practices that encourage the creditor to
swap loss is calculated as AUD 400. The limit under Sec-
tion 63F(2) is the amount of debt owing (i.e. AUD 600)
less any previous deduction (i.e. AUD 200 in situation 2
23. This example is an updated version of an example provided in the Explana-
and AUD 350 in situation 2A). The limit, therefore, is tory Memorandum to illustrate the general operation of the section.
AUD 400 for situation 2 and AUD 250 for situation 2A. 24. Sec. 245-65(4) treats the money so used by the debtor as consideration for
The swap loss allowable under Section 63E(3) is AUD the debt forgiven.
© 1999 IBFD Publications BV
8 ASIA-PACIFIC TAX BULLETIN JANUARY 1999

allow debtors to continue to trade with consequential be- interests of the state in the collection of revenue and those
nefits to the creditor, debtor and the national economy. of the creditor in seeking to obtain an equitable adjustment
Section 63E provides a comprehensive and equitable treat- to their taxable situation following the swap.
ment of debt-for-equity swaps that balances the respective

L O O S E - L E A F S E R V I C E S

Taxes and Investment in

Asia and the Pacific
This loose-leaf service, compiled and maintained with the help of profession-
als in the respective countries, provides detailed information on all countries
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© Capital and property taxes
© Indirect taxation: VAT/sales tax, customs and excise duties
© Tax incentives
© International tax aspects

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