Edited version of your private ruling

Authorisation Number: 1012456781801

Ruling

Subject: Interest expenses

Question

Are you entitled to a deduction for a portion of the interest expense on your loan after the cessation of your business where no funds are available to repay the loan?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

You started a business and borrowed $X.

The loan was an extension of your home loan.

The business was not successful so you ceased to operate the business and sought alternative employment

A $X debt from your moneys borrowed for the business was outstanding after using the sale proceeds to pay outstanding debts.

You regularly repay the loan each month with principal and interest repayments.

You do not have sufficient funds to pay out the business loan.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (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.

The courts have considered a number of cases involving the deductibility of losses and expenditure incurred after the cessation of a business. Commissioner of Taxation v. Jones (2002) 117 FCR 95; 2002 ATC 4135; (2002) 47 ATR 638 (Jones Case) involved the deductibility of interest payments incurred on a loan refinanced prior to the cessation of a business, where the interest payments related to later years of income in which no relevant assessable income was derived.

In dismissing the appeal by the Commissioner, Beaumont, Finn and Sundberg JJ agreed with the earlier reasoning of Dowsett J (Commissioner of Taxation v. Jones 2001 ATC 4607; (2001) 47 ATR 638) that the taking out of the loan while the business was still operating created an obligation to pay interest until such time as the loan was repaid. In other words, the obligation to pay interest would continue after the business had ceased until an event or circumstance arose to break the necessary nexus. As a result, it was determined that the interest payments were allowable deductions.

The decision in Jones Case also supported earlier court decisions that business losses incurred in later years of income could be deductible as long as the occasion of the outgoing could be related back to a period prior to the business ceasing operations.

The Commissioner's view on the deductibility of interest expenses following the cessation of the relevant income producing activity is considered in Taxation Ruling TR 2004/4.

TR 2004/4 states at paragraphs 10-14:

Where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period.

Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgment about the nexus between the outgoing and the income earning activities.

An outgoing of interest in such circumstances will not fail to be deductible merely because:

· the loan is not for a fixed term;

· the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty; or

· the original loan is refinanced, whether once or more than once.

However, if the taxpayer:

· keeps the loan on foot for reasons unassociated with the former income earning activities; or

· makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred,

· the nexus between the outgoings of interest and the relevant income earning activities will be broken.

A legal or economic inability to repay is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities.

In your situation, you borrowed money to purchase a business. The business then ceased. After using the proceeds from the sale to pay outstanding business debts and to reduce the loan, an outstanding amount of approximately $X remained on your loan.

Following the sale of your business, you have continued to make principal and interest repayments on your loan. You do not have sufficient funds to pay out your business loan. It is considered that the interest is a burdensome legacy of the past as in Browns case and Jones case. As there is an economic inability to repay your business loan, it is not considered that the loan is being retained for purposes other than the production of assessable income. Given that you do not have additional funds to pay off the loan and avoid incurring ongoing interest liabilities, it is considered that the interest outgoings have the necessary character of incidental and relevant outgoings. As such the associated interest expenses are an allowable deduction under section 8-1 of the ITAA 1997.

As your loan is for mixed purposes, you will need to apportion the expenses between the private and income-producing portions of the loans. Only that portion of the expenses relating to the production of business income will be allowed as a deduction.

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).