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Edited version of private ruling

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Ruling

Subject: Interest expense on borrowing on-lent to a family trust

Are you entitled to deduction for interest expenses incurred after the cessation of business activity, where your borrowings were on-lent to your family trust to conduct the former business activity?

No.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You borrowed money at commercial rates and on-lent those funds to your family trust. The on-lent money was used to purchase a business in partnership. During the period of trading, interest at commercial rates was paid to you by your family trust. The partnership also paid you wages. The business traded for four years and was sold. As the proceeds of sale were insufficient to meet all of the outstanding financial obligations, the original loans remain outstanding.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Taxation Ruling IT 2385 states the Commissioner does not allow deductions to beneficiaries of trusts in relation to trust income unless it is established the beneficiaries were presently entitled to the trust income when the expenditure was incurred.

It follows beneficiaries of discretionary trusts cannot claim deductions for expenses incurred during an income year because whether any beneficiary is presently entitled to a share of income of a discretionary trust is determined on the last day of the financial year.

This tax treatment was affirmed by Taxation Board of Review No.3 Case M36 80 ATC 280; (1980) 24 CTBR (NS) Case 11 and again by Administrative Appeals Tribunal Case U44 87 ATC 318 (Case U44).

In Case U44, the taxpayer was a beneficiary of a discretionary family trust. The trust carried on a business. For the 1983 year, the trustee exercised its absolute discretion to distribute the balance of the income of the trust to the taxpayer. In his tax return for the 1983 year, the taxpayer disclosed as assessable income the distribution from the trust and claimed deductions for various trust expenses which he had met personally. The Tribunal held, at its highest, the taxpayer only had an expectancy to be considered as a potential recipient of trust income. He had no right to demand a share of the trust income. The Tribunal held for the expenditure to be an allowable deduction, it must be shown that a claimant is presently entitled to a share of the trust income of the trust estate. As a sufficient nexus had not been shown between the expenditure on behalf of the trust and the derivation of the taxpayer's assessable income, taxpayer was not entitled to a deduction for the expenditure.

Regarding the principle that present entitlement to a share of income of a trust is determined on the last day of the financial year, this was affirmed in the High Court of Australia case of Union Fidelity Trustee Co. of Australia v. Federal Commissioner of Taxation (1969) 119 CLR 177; 69 ATC 4084; (1969) 1 ATR 200, where Chief Justice Barwick said:

To conclude, you are not entitled to claim deductions for interest expense incurred after the cessation of the business activity conducted by your family trust. Your circumstances are the same as those in the Taxation Board of Review and Tribunal cases cited above, where similar claims for deductions were disallowed.

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