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Ruling

Subject: Interest expenses

Question 1

Are you entitled to a deduction for 100% of the interest expenses on money borrowed against your private residence where the borrowed funds were used to purchase a unit in a trust?

Answer

No.

Question 2

Are you entitled to a deduction for a portion of the interest expenses on money borrowed against your private residence where the borrowed funds were used to purchase a unit in a trust?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2011
Year ended 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You acquired units in a Trust.

The trust acquired a property which was used to generate a rental yield.

You funded the purchase of the units through savings and a loan secured against your private residence.

You have incurred interest expense on the borrowing.

The Trust Deed:

· stated a beneficiary could be the unit holder or a person or entity related to the unit holder

· gave the trustee the right to distribute the net income, different types of income, tax credits and tax rebates of the Trust to beneficiaries other than the unit holder

· listed you as a unit holder.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Summary

The interest incurred by you on a loan used to purchase units in the Trust which was established to benefit yourself and others cannot be deducted in full under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997). The deduction for interest expenses should be limited to the amount of income received as a trust distribution.

Detailed Reasoning

Section 8-1 of the ITAA 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, or relate to the earning of exempt income or a provision of the taxation legislation excludes it.

The deductibility of interest on borrowed funds is determined by the use of the borrowed money.

Taxation Determination TD 2009/17 states that interest on a loan used to settle moneys on trust to benefit the borrower and others cannot be deducted in full under section 8-1 of the ITAA 1997.

The taxpayers' interest expense can only be deducted to the extent to which the taxpayer has used the borrowed moneys to gain or produce assessable income of the taxpayer. The interest will not be deductible to the extent that the taxpayer has used the borrowed moneys for the purpose of benefiting persons other than the taxpayer.

The conclusion that the taxpayer has used the borrowed moneys to benefit others will usually follow objectively from the terms of the trust.

The terms of the trust will usually provide an objective basis for characterising whether the taxpayer has used the borrowed moneys for the purpose of gaining or producing their assessable income.

The interest expense is not deductible at all where the terms of the trust are such that no connection is perceived between the interest outgoing and the taxpayer's assessable income, or where section 51AAA of the Income Tax Assessment Act 1936 applies.

Arrangements with which TD 2009/17 is concerned

TD 2009/17 is concerned with the deductibility of interest expense on borrowed moneys which are settled on trust to benefit the borrower and others. The arrangements addressed by this Determination include the commercial trust arrangements described in Taxpayer Alert TA 2008/3. Arrangements of that kind typically display some or all of the following features:

(a) The taxpayer arranges for the establishment of a trust. The trustee of the trust is either the taxpayer, or is controlled by the taxpayer and/or associates of the taxpayer.

(b) The beneficiaries of the trust are the taxpayer and his or her associates (the other beneficiaries). The other beneficiaries are members of the taxpayer's family and/or entities which the taxpayer and/or the taxpayer's associates control; they do not usually contribute any capital to the trust, nor do they provide money or property to the taxpayer.

(c) The taxpayer borrows money at interest and settles it on the trust. The trustee issues units to the taxpayer. The units provide the taxpayer with particular rights to trust income and/or capital.

(d) The trustee uses the money in paragraph (c) to purchase one or more income-producing assets. Typically, the assets comprise real estate or shares.

(e) The trust deed, and/or the trustee acting under the authority of the trust deed, determines how much of the income of the trust is available for distribution to beneficiaries.

(f) The taxpayer's units do not give the taxpayer an entitlement to all of the benefits which may reasonably be expected to be produced by the asset(s) in paragraph (d). Alternatively, an objective implication to be drawn from the trust deed is that the taxpayer cannot reasonably expect to receive all such benefits.

For example, the taxpayer's units:

(i) may carry no entitlement to share in realised capital gains of the trust;

(ii) may carry no entitlement to share in anything other than realised capital gains of the trust;

(iii) may carry an entitlement to share in only part of the income of the trust; or

(iv) may be redeemable, at the trustee's discretion, for an amount which fails to reflect the taxpayer's contribution to the trust (for example, the cost of the units or their market value, where such value reflects the limited nature of the rights which the units carry).

(g) For a number of financial years, the amounts included in the taxpayer's assessable income because of his or her unit holding are significantly less than the interest expense on the borrowing. The taxpayer claims that the interest expense is deductible in full under section 8-1 of the ITAA 1997.

Application to your circumstance

You used equity in your principal place of residence to borrow money from a financial institution. You used this borrowed money towards the purchase price of units in the Trust.

The Trust purchased a property which was subsequently rented out.

You are a beneficiary of the Trust as well as a registered holder of units in the Trust.

The Deed of the Trust allows the Trustee absolute discretion in making a determination to distribute or accumulate income. Further, the Trustee has the absolute discretion to decide the amount (if any) of net income, different type of income, tax credits and tax rebates to be distributed and to whom it shall be distributed.

The net income, different type of income, tax credits and tax rebates will only be distributed to the unit holders where the Trustee has not made a resolution as to the distribution or the resolution is not effective at law.

It cannot be determined that you can reasonably expect to receive any or a proportionate share of the income, according to your unit holding, from the Trust.

A loss or outgoing is not deductible where it is incurred in order to gain or produce the assessable income of other entities. The borrowed funds have been settled on the trust for the benefit of yourself and others and the funds are not being used solely for the purpose of gaining or producing your assessable income.

As such, apportionment of your interest deduction is required and your interest deduction in each year should be limited to the amount of income from the trust to which you are presently entitled.

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