More often than not, individuals forgive each other and cancel out debts. However, in as much as a cancelled or written off debt provides some form of comfort to the debtor, it is imperative that we understand that such cancellation actually triggers tax in the hands of the debtor i.e., the person relived of the obligation to pay. Allow us to give you some insight on how one may end up with a tax obligation upon cancellation of their loans. In this article, words importing the masculine shall be deemed to include the feminine.
When a creditor forgives a debt or loan due to them by a debtor, the debtor technically obtains a financial benefit in the sense that they are absolved of the obligation to extinguish such debt. Consequently, loans forgiven are inherently the same as donated cash in as far as tax is concerned. Accordingly, a cancellation of a loan is liable to donations tax. The tax is payable by the donee or beneficiary, in this case the debtor and it is charged per the provisions of the Capital Transfer Tax Act, one of the least known and applied Tax Acts in the country. For the avoidance of doubt, the tax is only charged where a loan was interest-free, i.e. where interest was charged, no Capital Transfer Tax applies.
The tax laws prescribe that the tax is levied on the value of ‘any gratuitous waiver or renunciation of a right.’ Technically, this is referred to as a chargeable disposal. In the same vein, the term gratuitous means to give away freely without any charge or any recompense. To put everything into perspective, where a loan is forgiven, technically, a right to receive cash is waived in exchange for sympathy or another non-monetary endeavour. Accordingly, the act of forgiving someone something with monetary value falls in the ambit of a chargeable disposal that is subject to Capital Transfer Tax or Donations Tax. However, not every Pula forgiven is liable to tax.
As alluded to above, not every Pula forgiven is liable to tax. The above-mentioned Act provides that the tax will not apply to loans below the value of P25,000. It is key to note that this minimum threshold applies to both companies and individual taxpayers. On the other hand, it is vital to note that interest bearing loans that are forgiven are liable to normal business tax i.e., income tax. Essentially, this means that for a person in business i.e., individual or company, a forgiven or cancelled interest-bearing debt or loan is free from donations tax. However, the same attracts income tax.
Loans forgiven are not in any way different from donated cash, hence liable to donations tax. However, it is key to note that Donations’ tax is applicable on loans in excess of the P25,000 threshold. Further, the tax is only applicable on non-interest-bearing loans.
Well folks, we hope that was insightful. As us, the two Yours Truly say goodbye, remember to pay to Caesar what belongs to him. If you want to join our free Tax WhatsApp group, send us a text on the cell number below.