Edited version of private ruling

Authorisation Number: 1011573424237

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Interest deduction for a Division 7A loan

Question 1

Is all of the interest paid on a Division 7A loan from a trust where you used the borrowed funds to invest in a term deposit, an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is part of that interest an allowable deduction under section 8-1 of the ITAA 1997?

Answer

Yes. You can claim a deduction equal to the interest income from the term deposit.

This ruling applies for the following period:

Year ended 30 June 2009

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You were a beneficiary of a discretionary family trust.

The trust held an unpaid present entitlement owing to a corporate beneficiary.

You were a shareholder, or associated with shareholders of the corporate beneficiary.

The trust lent you money from the unpaid present entitlement which you invested in a term deposit with a bank.

This was a Division 7A loan.

The term deposit paid you interest for the year ended 30 June 2009.

The trust charged you interest which was calculated using the prescribed rate of 9.45% (as explained in Taxation Determination TD 2008/19) for repayments during the year ended 30 June 2009.

The interest charged by the trust was much greater than the interest you earned from the term deposit.

You repaid the loan in full by 30 June 2009.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 109D(1)

Income Tax Assessment Act 1936 subsection 109D(1AA)

Income Tax Assessment Act 1936 subsection 109N(1)

Income Tax Assessment Act 1936 subsection 109N(2)

Income Tax Assessment Act 1936 subsection 109N(3)

Income Tax Assessment Act 1936 subsection 109XA(2)

Income Tax Assessment Act 1936 paragraph 109XA(2)(b)

Income Tax Assessment Act 1936 subsection 109XB(1)

Income Tax Assessment Act 1936 subsection 109XB(2)

Income Tax Assessment Act 1997 subsection 8-1(1)

Income Tax Assessment Act 1997 subsection 8-1(2)

Does Part IVA apply to this ruling?

No.

Reasons for decision

Summary

We consider that you did not obtain the loan solely to earn assessable income. The interest earned by your term deposit was less than the interest incurred on the borrowed money, and could never exceed that expense. Therefore only a portion of the interest paid on the loan is allowable as a deduction. We will allow a deduction to the extent of the interest income earned.

Detailed reasoning

Under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) a deduction can be claimed for expenses incurred in gaining assessable income except to the extent that the expenses are of a private, domestic or capital 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. The 'use' test, established in FC of T v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

In your case, you borrowed money with the intention of earning interest from the term deposit. The interest derived from the term deposit was assessable income attributable to the funds borrowed. A deduction for some amount of interest is therefore appropriate. However, in Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613 (Fletcher) the Full High Court took the view that if, on consideration of all the factors, the whole of the interest could be characterised as genuinely incurred in gaining or producing assessable income, the interest would be fully deductible. If only part of the outgoing could be so characterised, apportionment between the pursuit of assessable income and of other objectives was necessary. As set out in Taxation Ruling TR 95/33, we follow the principles laid down in Fletcher when determining whether interest deductions are fully deductible.

It is considered that in your circumstances you did not obtain the loan solely to earn assessable income. Your term deposit was for a short term. The loan was paid off within one year. The interest earned by your term deposit was less than the interest incurred on the borrowed money, and could never exceed the expenses. Therefore only a portion of the interest paid on the loan is allowable as a deduction. Based on all the circumstances we will allow a deduction to the extent of the interest earned on the term deposit in the year ended 30 June 2009.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).