• The impact of this case on ATO policy is discussed in Decision Impact Statement: Tanti and Commissioner of Taxation (Published 6 October 2010).

TANTI v FC of T

Members:
R W Dunne SM

Tribunal:
Administrative Appeals Tribunal, Adelaide

MEDIA NEUTRAL CITATION: [2010] AATA 549

Decision date: 23 July 2010

---

Senior Member R W Dunne

Introduction

1. In this case, the applicant (Mr Leonard Tanti) objected against his assessment for the year ended 30 June 2007. He contended that the taxable income disclosed by him in his return should be reduced by an amount of $18,099, being interest paid or payable on loans made to him by his mother which he on-lent interest free to a company in which he was sole shareholder and director.

2. At the hearing, Mr Tanti's mother (Ms Judith Tanti) represented him and Mr Ray Riviere (from the ATO Legal Services Branch) appeared for the respondent. The Tribunal received into evidence the T documents (Exhibit R1) and the supplementary T documents (Exhibit R2) lodged pursuant to s 37 of the Administrative Appeals Tribunal Act 1975. At the request of the parties, the Tribunal also received the applicant's outline of argument (Exhibit A1) and the respondent's statement of facts, issues and contentions (Exhibit R3).

Issue for the tribunal

3. The issue for the Tribunal is whether the applicant is entitled to a deduction of $18,099 (or some lesser amount) under s 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of interest paid or payable on funds borrowed from the applicant's mother and on-lent interest free to a company in which he was sole shareholder and director.

4. I note that, in connection with the issue in paragraph 3, under s 14ZZK(b) of the Taxation Administration Act 1953 (TAA) the onus is on the applicant to establish that his assessment for the year ended 30 June 2007 is excessive. I was advised by Ms Tanti that the applicant would not be appearing to give evidence. She was fully informed about the facts of the applicant's case and he had instructed her to represent him at the hearing.

Legislation

5. Interest is tax deductible to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, and is not of a capital, private or domestic nature. Relevantly, s 8-1 of the ITAA 1997 reads:

• "8-1 General deductions
  • (1) You can deduct from your assessable income any loss or outgoing to the extent that:
    • (a) it is incurred in gaining or producing your assessable income; or
    • (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
    • Note: Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income.
  • (2) However, you cannot deduct a loss or outgoing under this section to the extent that:
    • (a) it is a loss or outgoing of capital, or of a capital nature; or
    • (b) it is a loss or outgoing of a private or domestic nature; or
    • (c) it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or
    • (d) a provision of this Act prevents you from deducting it.
  • …"

Background

6. The facts of this case are not in dispute and can be relevantly extracted from the applicant's outline of argument and the respondent's statement of facts, issues and contentions. On 30 September 2004, Mr Tanti formed a company, Tannel Pty Ltd (Tannel), in which he was sole shareholder and director. Tannel was established for the purpose of entering into a franchise arrangement with Allphones Retail Pty Ltd. Tannel borrowed funds from the Commonwealth Bank by way of a business line of credit in the amount of $195,000. The business line of credit was used in Tannel's franchise business and was secured by registered mortgages over rental properties belonging to Mr Tanti and his mother. Tannel was paying interest on the line of credit and was correctly claiming the interest as a deduction in its income tax returns.

7. Between 1 September 2005 and 24 May 2006, Mr Tanti borrowed a total of $250,000 from his mother, at varying rates of interest, under the following written loan agreements:

• • loan agreement dated 1 September 2005 for $100,000;
• • loan agreement dated 19 October 2005 for $95,000;
• • loan agreement dated 14 December 2005 for $50,000; and
• • loan agreement dated 24 May 2006 for $5,000.

8. In relation to the loans for $100,000 and $95,000 respectively, on 1 September 2005 and 19 October 2005, Mr Tanti on-lent the funds interest free to Tannel, which in turn applied the funds to reduce its line of credit with the Commonwealth Bank. There were no written agreements between Mr Tanti and Tannel to evidence these loans. On 26 October 2005, Mr Tanti withdrew $50,000 from Tannel's business line of credit. He used the withdrawn funds to purchase shares in a private company, Microbric Pty Ltd. In relation to the loan of $50,000 made on 14 December 2005, Mr Tanti used the borrowed funds to repay Tannel the amount of the line of credit withdrawal made on 26 October 2005. In addition to the loan of $5,000 made on 24 May 2006, Ms Tanti loaned the applicant an amount of $72,995 on 23 February 2007, which was effectively a re-negotiation of the balance owing (including interest) on the earlier loans as at 23 February 2007.

9. On 5 November 2007, Mr Tanti lodged an income tax return for the year ended 30 June 2007 with the respondent. In that return, he disclosed income from salary and wages totalling $72,475 received from two unrelated employers (Harris Scarfe and the Coventry Group) not connected with the applicant or the present application. He did not disclose any income from Tannel in his 2006/2007 income tax return. On 9 November 2007, his 2006/2007 assessment issued, based on the taxable income he had disclosed in his income tax return. On 3 March 2009, he objected against the assessment, contending that his taxable income should be reduced by $18,099, being interest paid or payable on the loans made to him by his mother between 1 September 2005 and 23 February 2007. In the objection, Mr Tanti stated that the loans were used "solely for producing assessable income" and "to reduce my Business Line of Credit which was set up to provide working capital for my business activities; Tannel Pty Ltd (Trading as Allphones Elizabeth)". In a spreadsheet titled "Loans Len/Tannel 2007 Returns" interest calculations were provided by the applicant and may be summarised as follows:

• • interest on loan for $100,00-$10,104;
• • interest on remaining loans ($95,000, $50,000, $5,000 and re-negotiated loan of $72,995)-$7,995.

10. A decision to sell Tannel's business was made by Mr Tanti on or about 19 November 2005 and an agreement for sale was entered into on 18 May 2006. The agreed sale price was $120,000, which was paid on 29 May 2006 ($90,000), on 7 July 2006 ($27,788.22) and on 18 July 2006 ($2,211.78). From the sale proceeds of the business and during the period from 31 May 2006 to 30 August 2006, the sum of $120,806.57 was repaid by Tannel to Mr Tanti against the loans that had been made by him to the company.

11. In providing further background facts, Ms Tanti said that, although there were no agreements between the applicant and Tannel in relation to the loans he had made to the company, loan agreements were made in respect of the funds she loaned to the applicant, with terms to accommodate progress payments she was to make on a home she was building. The interest rate of those loans was in each case lower than the bank interest rate. Advice was sought from Mr Tanti's accountant as to how the interest on the loans should be treated for income tax purposes. No interest was paid in the 2005/2006 tax year and the issue of deductibility was deferred until the 2006/2007 tax year. When the 2006/2007 taxation returns were prepared, a deduction for the interest was not included in Mr Tanti's return, necessitating the eventual lodgement of the objection. Ms Tanti said the applicant was paid wages by Tannel during the 2004/2005 tax year. He also worked part-time in Tannel's business, taking no wages for his labour.

Consideration

Is the applicant entitled to a deduction for any part of the interest that was paid or payable to his mother in respect of the year ended 30 June 2007?

12. Like any other loss or outgoing, to be tax deductible, interest must satisfy the general deduction provision in s 8-1 of the ITAA 1997. This allows a deduction for all losses and outgoings to the extent to which they:

• (a) are incurred in gaining or producing assessable income (the "first limb"); or
• (b) are necessarily incurred in carrying on a business for the purpose of gaining or producing such income (the "second limb").

13. The expression "assessable income" includes employment income, business income, dividends, interest and other types of income. However, no deduction is allowable under s 8-1 for expenses that are of a capital, private or domestic nature, or are incurred in gaining or producing exempt income.

14. In the present case, Mr Tanti was the sole shareholder in, and sole director of, Tannel, a company carrying on business as an Allphones franchisee. Tannel had borrowed funds from the Commonwealth Bank by way of a business line of credit, the balance of which stood at $195,000 at 19 July 2005. Tannel was paying interest on that line of credit and was claiming the interest as a tax deduction in its income tax returns. During the 2006/2007 tax year, Mr Tanti claimed a tax deduction for interest paid or payable to his mother on funds she had loaned to him between 1 September 2005 and 24 May 2006. These loans totalled $250,000. It appears there was an additional loan amount which was effectively a re-negotiation of the balance owing by the applicant to his mother (including interest) on the earlier loans, as at 23 February 2007. The loan funds of $250,000 were on-lent by Mr Tanti interest free to Tannel which, in turn, used the funds to reduce or extinguish its line of credit with the Commonwealth Bank

15. In referring to the T documents, I note that the business conducted by Tannel had not been profitable for some years. It had made losses in the 2004/2005 tax year, in the 2005/2006 tax year and in the 2006/2007 tax year. It appears that the lack of profitability had been due, in part, to increasing local competition and eventually led Mr Tanti to decide to sell the business. Of the loan funds of $250,000, $50,000 was used by Mr Tanti to repay an amount he had withdrawn from Tannel's line of credit and which he had used to purchase shares in Microbric Pty Ltd. For the respondent, Mr Riviere accepted that, of the interest of $18,099 claimed as a tax deduction, an amount of $3,610 was allowable as a deduction under the first limb of s 8-1 of the ITAA 1997 in respect of interest incurred on funds borrowed by the applicant for the specific purpose of purchasing the shares in Microbric Pty Ltd. I agree that the deduction of $3,610 is properly allowable.

16. As to the remainder of the loan funds and the interest of $14,489 claimed as a deduction in respect of those funds, Ms Tanti contended in the applicant's outline of argument that "the interest was incurred in the course of the business activity which was directed towards the gaining or producing of assessable income". The problem with this contention is that it is unclear which entity's business activity was intended. It is also unclear which entity's assessable income was involved and how the interest incurred was directed towards the gaining or production of that assessable income. According to the evidence, Mr Tanti was an employee of Tannel and had been so from the date the company was established and commenced its business. There was no evidence that, since 30 September 2004, he himself had been engaged in any business or business activity. I also note from the supplementary T documents (Exhibit R2, ST2 at page 3) that he did not receive any income by way of salary, director's fees, dividends or interest from Tannel in respect of the 2005/2006 and the 2006/2007 tax years. In the circumstances, to be deductible to Mr Tanti, the interest of $14,489 must have been incurred in gaining or producing his assessable income under s 8-1(1)(a) of the ITAA 1997. The interest can only be said to be incurred in gaining or producing his assessable income and hence deductible if the interest bears a sufficiently close connection with the activities by which the assessable income is produced (see
Fletcher & Ors v FC of T 91 ATC 4950;
FC of T v J D Roberts & Smith 92 ATC 4380). There was no connection between the interest and the applicant's activities as an employee of Tannel. Nor was there any connection between the interest and any director's fees, dividends or interest he might have received from Tannel. Thus, the interest was not incurred in gaining or producing his assessable income under s 8-1(1)(a). Nor was the interest necessarily incurred in carrying on a business for the purpose of gaining or producing such income under s 8-1(1)(b). The only entity that could have been entitled to a deduction for the interest of $14,489 was Tannel itself, but that company did not incur the interest as a business expense.

17. Ms Tanti also contended that the facts of the applicant's case were substantially similar to those in
FC of T v Total Holdings (Aust) Pty Ltd 79 ATC 4279. In that case, Total Holdings was a member of the multi national Total group. The policy of that group was to establish local trading companies in various countries with the intention that those companies become profitable as soon as possible. Total Holdings acquired an Australian operating company, Total (Australia) Limited (TAL) in 1957. Total Holdings borrowed funds from its parent company at interest and over the period 1 January 1960 to 31 December 1968 on-lent part of those funds to TAL interest free, as this was the best method of establishing TAL as a profit making entity and presenting its accounts in a favourable light. The evidence also showed that it was intended that, once TAL was profitable, those profits would be remitted to Total Holdings, by way of dividends and interest. In the Full Federal Court, Lockhart J, with whom Northrop and Fisher JJ agreed, held (at ATC 4283):

"… if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income producing activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under s S51."

The Court found that the on-lending of monies interest free was designed to render TAL profitable as soon as commercially feasible and to promote the generation of income by TAL and its subsequent derivation, either as dividends or interest, by Total Holdings. Consequently, Total Holdings was entitled to a deduction in respect of the interest paid by it on funds which were on-lent interest free to TAL.

18. In my view, the facts of Total Holdings are distinguishable from the facts in the applicant's case. Although the funds borrowed from his mother were on-lent interest free to Tannel, there was no prospect of him deriving an income from the company, whether as dividends or interest, in the future. Tannel was not a profitable entity and he sold the business of the company in May 2006, prior to the year of income in which a deduction was sought for the interest paid (or payable) to his mother.

19. In summary, the applicant is entitled to a deduction, under s 8-1(1)(a) of the ITAA 1997, for interest of $3,610 paid or payable in respect of the year ended 30 June 2007 for funds of $50,000 borrowed from his mother to purchase shares in Microbric Pty Ltd. The applicant is not entitled to a deduction, under s 8-1(1) of the ITAA 1997, for interest of $14,489 paid or payable in respect of the year ended 30 June 2007 for other funds borrowed from his mother and on-lent interest free to Tannel.

20. The situation in Mr Tanti's case is not uncommon. There are numerous Tribunal decisions involving claims for deduction for interest incurred in circumstances similar to those of the applicant. In those cases, no deduction was allowable for the interest that had been incurred: see
Case U134, 87 ATC 780;
Case 26/94, 94 ATC 258;
Case 48/97, 97 ATC 500;
Case 51/97, 97 ATC 543.

21. At page 2 of the applicant's outline of argument, reference is made to certain amounts being claimed as deductions for interest in assessments for the years ended 30 June 2008 and 30 June 2009. These assessments are not before me in this application and do not require my consideration. The applicant also raised the issue of penalties in his outline of argument. The Tribunal notes that no penalties were imposed in the applicant's assessment for the 2006/2007 tax year. The issue of penalties does not require consideration by me in this application.

Decision

22. For the reasons that have been outlined, the Tribunal varies the decision under review to the extent indicated in paragraph 19 above.