Edited version of private ruling

Authorisation Number: 1011570984125

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Ruling

Subject: Interest deductions and Part IVA

Questions:

1. Are you entitled to a deduction for the interest you incur on your loan used to acquire an investment property?

Answer: Yes.

2. Will the provision of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) be applied to an arm's length arrangement to purchase your spouse's investment property?
Answer: No.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on:

1 July 2010

Relevant facts:

Your spouse is currently the sole legal owner of an investment.

Your spouse has a loan relating to the property, with a balance of approximately $X0,000, from a licensed lender.

You believe the current market value of the property is approximately $XX0,000.

Your spouse now wants to cease full time employment and start a family and does not want the 'hassles' that go with owning a rental property and wishes to sell the investment property.

You believe the property is in a good location, provides a good return and is positioned for good capital growth in the future, and, therefore, propose to purchase the investment property from your spouse for its current market value.

You intend to confirm the market value of the property through an independent valuation.

You will obtain a loan for 100% of the purchase price of the property from the same licensed lender at normal commercial rates.

Your spouse proposes to use the proceeds of the sale of the property as follows:

· repay the $X0,000 still owing on the property

· to help family members in minor financial difficulty, and

· carryout renovations on the jointly held family home.

Your primary reasons for entering into this arrangement are to relieve your spouse of the responsibilities associated with the property and to build up an investment portfolio.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1.

Income Tax Assessment Act 1936 - Section 177A.

Income Tax Assessment Act 1936 - Section 177C.

Income Tax Assessment Act 1936 - Section 177D.

Reasons for decision

Interest expense

Section 8-1 of the Income Tax Assessment Act 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income.

In your case, you will be incurring interest on a loan which you will obtain to acquire an investment property. It is accepted this interest is incurred in producing assessable income and accordingly, you are entitled to a deduction for this expense.

Application of Part IVA

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances if a tax benefit is obtained in connection with a scheme, and it can be concluded that the scheme, or any part of it, was entered into for the dominant purpose of enabling a tax benefit to be obtained. Part IVA is a provision of last resort.

The application of Part IVA depends on the facts of the particular case.

In order for Part IVA to apply, the following questions must be addressed:

· Is there a scheme as defined by section 177A of the ITAA 1936?

· Is there a tax benefit which was obtained in connection with the scheme as defined by section 177C of the ITAA 1936?

· Is the scheme a scheme to which Part IVA applies, as determined by section 177D of the ITAA 1936, where it would be concluded that your main or dominant purpose of entering into the scheme was to obtain the tax benefit?

Is there a scheme?

For Part IVA to apply, the identified scheme must fall within the following wide definition of 'scheme'.

The definition applies to any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and any scheme, plan, proposal, action, course of action or course of conduct (subsection 177A(1) of the ITAA 1936).

In the present case, there is a 'scheme' as defined in section 177A of the ITAA 1936, being the following arrangement:

· the obtaining of a 100% loan to purchase your spouse's investment property at market value.

· your spouse using these proceeds to repay the remaining $60,000 of her existing loan on the property, to renovate a jointly held private residence and the remainder for personal use; and

· you will claim interest on your new loan as a deduction against your rental property income from the investment property.

Is there a tax benefit?

The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an 'alternative hypothesis' or a 'counterfactual. This is what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out. This alternative arrangement also forms the background against which the objective ascertainment of the dominant purpose of a person occurs in accordance with section 177D of the ITAA 1936.

The counterfactual would involve you obtaining the loan, but applying the borrowed funds directly to renovate your private residence and other personal uses. The counterfactual results in a loan where no deduction would be available for the interest.

The tax benefit identified is the difference between the interest incurred on the total balance of the new loan to purchase your spouse's investment property and the interest incurred on a loan attributed to the cost of renovating your private residence and other personal uses. (additional interest).

Objective purpose test

Section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which you have obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling you to obtain the tax benefit.

Section 177D of the ITAA 1936 refers to 'the purpose' of the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme. The person need not be you.

The objective test in paragraph 177D(b) of the ITAA 1936 is the core of Part IVA and has been described by the High Court as the 'pivot' or 'fulcrum' on which Part IVA turns. It is frequently referred to as the 'statutory predication test'.

The consideration of purpose or dominant purpose under paragraph 177D(b) of the ITAA 1936 requires an objective conclusion to be drawn. The conclusion required by section 177D of the ITAA 1936 is not about a person's actual, i.e., subjective, dominant purpose or motive. It is possible for Part IVA to apply notwithstanding that the dominant objective purpose of obtaining the tax benefit was consistent with the pursuit of commercial gain.

A conclusion about a relevant person's purpose for section 177D of the ITAA 1936 is the conclusion of a reasonable person based on all the facts and evidence that are relevant to considering the eight factors for the scheme. However, not all of the factors will be equally relevant in every case. Provided the eight factors are each taken into account, it is possible to arrive at the conclusion as to purpose by making a global assessment of purpose.

Consideration of the eight factors involves comparison of the scheme with the alternative arrangements (counterfactuals). In other words, the conclusion about the dominant purpose of a person entering into or carrying out the scheme, or any part of it, necessarily requires consideration of what may otherwise have occurred.

These eight factors are as follows:

(i) the manner in which the scheme was entered into or carried out

There is no artificiality in the arrangement. The transactions will be at market value and normal duties and other imposts will be incurred. The available interest deduction will be as a result of borrowings to purchase an income producing property, which is a normal commercial practice. It is within normal commercial practice and family dealings for taxpayers to buy and sell properties or otherwise arrange their affairs to improve their tax position. Your assertion that you could deal with the properties at arms length and the interest deduction would be allowable is valid, and a further example of normal commercial practice. Additionally, the proposed structure does not provide you with an advantage over the current structure, as you would own the investment property in your name solely and you would be entitled to a deduction for the interest on the loan relating to this property. This points against the application of Part IVA.

(ii) the form and substance of the scheme

The form is that you will borrow funds to purchase your spouse's investment property and you will subsequently derive arms length rental income and be entitled to a deduction for interest on the borrowings. But because there is no contrivance or artificiality present, the arrangement actually does exactly what it appears to do, and nothing else. The available interest deduction occurs legitimately as a result of the normal commercial dealing of borrowing to purchase an income producing property. Hence, the substance is consistent with the form. This points against the application of Part IVA.

(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out.

The timing aspects are not significant to you purchasing the investment property. Hence, this factor is neutral with regard to the application of Part IVA.

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by this scheme

The tax result is that you can claim a deduction for interest expenses on the loan to purchase the investment property. In isolation, a enduring tax deduction would point to the application of Part IVA. However, when considered in conjunction with the other factors, this factor is neutral.

(v) any change in the financial position of the relevant taxpayer that has resulted, or will result, or may reasonably be expected to result, from the scheme

You will take on the liability for a loan and interest payments in exchange for the title to the investment property, and then receive arms length rental income and claim interest deductions. As these financial changes are consistent with what would be expected from such an arrangement, this factor is therefore neutral as to the application of Part IVA.

(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result, or may reasonably be expected to result, from the scheme

Your spouse will receive the funds from your new loan in exchange for the title to their investment property, and then will not receive rental income. As these financial changes are consistent with what would be expected from such an arrangement, this factor is therefore neutral as to the application of Part IVA.

(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out

There is no indication of any other consequence as a result of you entering into the proposed scheme.

The title to the investment property will transfer from your spouse to your name solely. As this is consistent with normal commercial practice, this factor is therefore neutral.

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi)

You have a family relationship with the person from whom you wish to purchase the investment property (for example, your spouse). However, when considered in conjunction with the other factors, this factor will be neutral with regard to the application of Part IVA.

Conclusion:

All these factors either point against the application of Part IVA or are neutral. Part IVA will therefore not apply to this arrangement.

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