Is getting a debt writedown a gift? Would you have to pay tax on it?

The US model of ‘short sales’ has a hidden sting in it that often gets lost in the noise, namely that the reduction of your debt is often considered a gain and it needs to be reported on your IRS Form 1099 (as opposed to a W2 or 1040) which covers income outside of wages/salaries/gratuities.

Which means that if you sold your property (we’re assuming it is in negative equity) for a €50,000 loss and the bank write that off, that in effect you have a non deductible loss which you didn’t pay and therefore you pay the tax on it (their equivalent of capital gains).

Like the US, Irish investors can offset capital losses against capital gains, in the case of your own home this doesn’t apply. In the American example a write-down creates a tax liability, although not in every state (my home-state of California being an example). This was becoming such a problem that the IRS brought out two special tax codes called ‘The mortgage forgiveness debt relief act & debt cancellation act of 2007’.

Is there any similar provision in Ireland? No…

Is that a problem?… No.

Because the Capital Acquisition tax & tax consolidation act 2003 have no provision stating that a debt write-down constitutes a gift or gain on a commercial agreement carried out at arms length.

Thankfully there is no lacuna, the recent Bank of Ireland debt write down case would be an example to prove the point. If this had happened in the US and the above acts were not in place there would be a CGT implication of c.15% (long term band) or about €22,500!

it is worth remembering that there are aspects of ‘the American way’ that we don’t consider when seeking to embrace their model of ‘short sales’.

Comments

  1. Robert

    Careful there, Karl. You may be right that debt-forgiveness is tax free for the beneficiary in Ireland, but not for the reasons you have outlined.

    Firstly, the fact that the Capital Acquisition Tax Consolidation Act 2003 does not specifically state that debt forgiveness of bank debt is not a taxable gift, does not mean that it is specifically exempt. The starting point for the legislation is that all “benefits” are taxable, i.e. something received for nothing. If a taxpayer receives a “benefit”, the burden of proof is more on the taxpayer to show that a “benefit” is exempted from tax by the legislation than for Revenue to show that it is included. A father lending money to his son and then writing off the loan is certainly a “benefit” and a taxable one at that. There is nothing in the legislation that says debt forgiveness by a lending business should be treated any different.

    Secondly, we have no idea how Revenue will view the recent Bank of Ireland case. I would imagine that this type of quasi-bankruptcy arrangement only happens when the borrower has no other funds or assets – that bank is presumably going to get everything it can – so there is probably no point in Revenue chasing tax that by definition they will not be able to collect.

  2. Hi Robert,

    Thanks for the comment, excellent point. The instance you gave as example however could create a liability as it only satisfies one of two requirements mentioned ‘on a commercial agreement carried out at arms length’ – between family members is not at arms length even if the agreement is commercial.

    That is why I think the inter-family lending one is different anyway!

  3. Karl

    Donative intent is not required for gift tax to arise in Ireland, see the definition of disposition in section 2 CATCA 2003. Also see the specific provisions to exempt from CAT debt forgivness in bankruptcy and under the personal insolvency act.

    CGT is not an issue on debt forgiveness, CGT is a tax on assets not on liabilities, you cannot make a gain on a liability.

  4. @Karl (this is to the smarter ‘not me’ Karl) good point, can you expand on it? In the US it gets taxed like a gain (hence the CGT explanatory note, which we both agree it isn’t). On the CATCA 03′ http://www.irishstatutebook.ie/2003/en/act/pub/0001/sec0002.html I thought that ‘disposition’ section F might apply but queried this with Revenue directly who clarified the situation (and whose opinion is the basis of our blog post).

    The granting of a writedown outside of insolvency does not seem to be (their words not mine although I agree) a CAT event. Whatcha think?

  5. John

    An individual is deemed to take a Taxable gift when:

    – under any disposition
    – a person becomes beneficially entitled in possession
    – otherwise than on a death
    – to any benefit
    – otherwise than for full consideration

    if a debt is forgiven, the lender is deemed to make a disposition in favour of the borrower. The borrower has become beneficially entitled to a benefit otherwise than for full consideration.

    CATCA 1976 S2 – Disposition

    “h) the release, forfeiture, surrender or abandonment of any debt or benefit, or the failure to exercise a right, and, for the purpose of this paragraph, a debt or benefit is deemed to have been released when it has become unenforceable by action through lapse of time (except to the extent that it is recovered subsequent to its becoming so unenforceable),”

    This does seem as if a gift will arise. Any thoughts?

  6. @John the wording does seem to imply that for certain, that is what we were raising in the initial post (long before the problem resurfaced recently).

    I suppose that all we can do is go on the Revenue guidance offered to date which says otherwise. If they do change their mind it will be a massive blow for those already deep in debt – because even personal insolvency can’t save you from revenue liabilities. You’d have to go fully bankrupt

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