The Tax Appeal Commission ("TAC") recently held that debt forgiveness created taxable income for a taxpayer. Although the conclusion may be correct based on the specific facts of the case, the technical approach means that a successful appeal may be possible.
In 2007, a property development company received a bridging term loan (15 months) to purchase specific development land. The development did not proceed and the term was extended on multiple occasions. During this time, the taxpayer claimed tax deductions for the impairment of the land (which was held as trading stock) in its financial statements. In 2016, the bank agreed to forgive the €6,043,555 loan balance. Irish Revenue asserted the €6,043,555 forgiveness created taxable income for the taxpayer.
Irish Revenue advanced two key arguments:
(i) First, that the loan was revenue (and not capital) in nature. As a result, the forgiveness was a taxable revenue receipt.
(ii) Second, that the taxpayer had deducted the amount of the loan forgiven for tax purposes as it had claimed corresponding tax deductions for impairment of the property which the loan financed.
Irish tax law provides that taxable income arises to the extent amounts previously deducted for tax purposes are released (section 87 TCA). Section 87 TCA is designed to prevent a taxpayer deducting expenses (such as trade debts) for Irish tax purposes which are written-off and not ultimately borne by the taxpayer. The effect is to reverse deductions previously claimed if expenses are written off.
Arguably, a positive determination on one of Irish Revenue's key arguments should have resulted in the rejection of the taxpayer's appeal.
It appears that TAC accepted that the loan was revenue (and not capital) in nature because it was incurred for the purposes of the taxpayer's trade and was temporary and fluctuating in nature. Generally, this conclusion alone should have supported a determination that the loan forgiveness could have created taxable income for the taxpayer. However, the accounting treatment applied may have complicated this. The amount forgiven was included in the taxpayer's income statement as a credit below the gross profit line, so was arguably not taken into account in the computation of the taxpayer's trading profits for accounting purposes.
TAC also concluded that the taxpayer had claimed a tax deduction for the loan forgiven. This is because it had deducted equivalent amounts in its financial statements for impairments in value of the property. TAC concluded that section 87 TCA applied as a result and the taxpayer was required to reflect the amount of loan forgiveness as taxable income.
In our view, it is difficult to reconcile TAC's determination on section 87 TCA with the words used in the provision. The taxpayer did not claim a deduction in respect of the loan principal as payments of loan principal are not deductible for Irish tax purposes. The deduction claimed by the taxpayer was for a different expense altogether – an expense reflecting the reduction in value of the taxpayer's trading stock. In this regard, TAC seems to have stretched the application of section 87 TCA beyond its logical scope – perhaps in an attempt to reach the conclusion with which many practitioners would agree – that debt forgiveness of a revenue nature can be taxable in certain circumstances.
It is noteworthy that Irish tax legislation was previously amended to treat debt forgiveness as taxable income in property development trades carried on by natural persons. Similar provisions were introduced for capital gains tax purposes to restrict the use of capital losses in the case of debt forgiveness. The position for companies carrying on development trades was left in somewhat of a lacuna.
Overall, the conclusion that the debt forgiveness in this case may be taxable seems justifiable because of its revenue nature. However, the taxpayer's accounting treatment and the unusual application of section 87 TCA means that there are certainly points to be determined on appeal.