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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your private ruling

Authorisation Number: 1012543725613

Ruling

Subject: Deductibility of interest

Question:

Are you entitled to claim future deductions for interest on the investment loans following the collapse of X financial services?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

On or after 1 July 2004

Relevant facts

You engaged X financial services (herein referred to as financial services) to grow your wealth and income through investment in the stock market with listed securities.

Financial services's strategy was to encourage you to borrow as much ongoing money as possible during the investment period by using existing assets as security and to then use the acquired investments and other personal shares as equity to support an additional margin loan.

The effect of this gearing strategy was to gear you 100% into the stock market and further encourage the injection of surplus cash flow from employment or other sources to increase the gearing into the market.

The global financial crisis hit and the stock market began to fall. During this time your financial services adviser recommended you stay in the market.

The market continued to fall and you received a margin call to reduce a Margin Loan or inject additional capital, otherwise some you're your investments would be sold to achieve this result.

You were not in a position to reduce the Margin Loan or inject additional capital.

Your financial service's administered portfolio was sold/redeemed by the margin lender under the conditions within the margin loan following the margin call without any input from you.

This occurred later than it should have at a much higher LVR, resulting in a greater loss to you than should have been the case.

The resulting sale of the portfolio generated adequate funds to repay the Margin Loan in full and left you with a small amount of cash and a significant amount in bank investment loans outstanding.

The total capital loss suffered by you on the collapse of financial services through the margin loan operation and the gearing strategy was significant, and at the end of a previous financial year your carried forward losses totalled an amount after offsetting the previous year trust distributed gains.

Before the collapse you managed to prepay the Margin Loan and bank investment loan interest amounts for a previous financial year, which meant the requirement to make repayments on those bank Investment Home Loans for the year had been covered.

In the months following the financial services collapse the bank set up a review panel to look at individual taxpayers/investors positions to determine if compensation should be paid for their losses due to the gear strategy and loss suffered. The settlement process involved a law firm and a party acting for the bank and was known as the financial services resolution scheme.

You elected to have your position reviewed under the scheme and you were offered a resolution package which you accepted.

While the financial services resolution scheme was in progress, interest on all your bank investment loans was suspended by bank in for a later financial year. This meant that no interest needed to be paid on the two outstanding bank investment loans that were used in the financial services portfolio.

However you had already prepaid the interest on the smaller of the two bank investment loans prior to the bank interest suspension announcement.

The financial services resolution scheme offer that you accepted did not change the investment loan balances but they would be interest only loans at a flat X% rate for a period of Y years from 1 July 20XX after which they revert to a standard variable rate principal and interest loan.

The settlement between you and the bank allowed you the ability to remain in your home which would otherwise have needed to be sold to pay out the bank investment loans used in the financial services portfolio.

Given the terms of the resolution settlement with bank the interest incurred on the two bank investment loans used to fund the financial services portfolio recommenced in the 20YY year. You paid interest in the first financial year covered by the ruling.

The two bank investment loans used in the financial services gearing strategy have never changed in name since being taken out but their account numbers have been changed as a result of the financial services resolution scheme.

You have supplied the following documents, which form part of, and should be read in conjunction with this private ruling:

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 generally allows a deduction for interest on a loan used to derive assessable income.

Taxation Ruling TR 2004/4 Income Tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities (TR 2004/4) considers the deductibility of interest expenditure after the cessation of the relevant income earning activities, specifically at paragraphs 40 to 50.

At paragraph 44 of TR 2004/4, reference is made to Court cases that were decided by the Full Federal Court being FC of T v. Brown 99 ATC 4600; (1999) 43 ATR 1 (Brown) & FC of T v. Jones 2002 ATC 4135; (2002) 49 ATR 188 (Jones) In both Brown and Jones, the interest in question was incurred at a time after the relevant income earning activities had ceased and borrowed funds (or assets representing those funds, including goodwill) had been lost to the taxpayer. Even so, the Court had no difficulty in holding, in both instances, that interest incurred on the loans continued to be deductible despite the cessation of the relevant income earning activities.

A key factor in determining the deductibility of interest incurred after the income earning activities have ceased is whether or not the continuing liability to interest is seen as a burdensome legacy of the past (suggestive of a continuing nexus with prior assessable income) or whether the liability is seen to be associated with present or future advantages (suggestive of a broken nexus).

In your case, your continuing liability to interest is seen as a burdensome legacy of the past, it is a direct result of you having invested in financial services and your investments ceasing to exist when financial services collapsed sometime in 200X.

In your situation, your claim for interest deduction on the investment loans undertaken to finance investments in financial services will continue to be allowable even though the underlying investment no longer exists.

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