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Edited version of your written advice

Authorisation Number: 1012787253392

Ruling

Subject: Interest expenses

Question

Is the interest you paid on the company loans a deductible expense for you as an individual?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You were a director of a company that went into liquidation several years ago, permanently ceasing all operations at that time.

The company had business loans outstanding with a financial institution at the time of liquidation.

All the loans:

You continued to service all the loans until they were paid out.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Interest expenses may be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) where there is a sufficient connection to the earning of assessable income and the expense is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances.

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, regard must be given to all the circumstances including the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 (Munro's case) is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income.

Debts are normally incurred by a business in relation to their operations and, thus, the earning of the business's assessable income. As highlighted in Munro's case, a loss or outgoing will not be deductible if it is incurred in gaining or producing the assessable income of an entity other than the one who incurs it. For example, where expenses are incurred by a company and paid for by a director or someone else, a deduction is not allowable to the director or that other person.

Taxation Ruling TR 96/23 Income tax: capital gains: implications of a guarantee to pay a debt, discusses the deductibility of payments made under guarantee. The ruling states that liabilities arising under contracts of guarantee will not be deductible if the provision of guarantees is not regular and normal incidents of your income earning activities. The ruling further states that if the provision of guarantees is not a regular and normal incident of the taxpayers income earning activities, any payments made under those guarantees will be capital in nature.

Only if a taxpayer acts as guarantor to such a degree as to amount to his or her usual practice, say, as a solicitor, in the ordinary course of business will the payments be deductible as a revenue outgoing and not of a capital nature: Jennings (Inspector of Taxes) v. Barfield & Barfield [1962] 2 All ER 957; 40 TC 365.

In your case, you provided a guarantee to a number of loans in your company's name which has since gone into liquidation. The purpose of your actions was not to directly produce any assessable income for yourself, but to fulfil your commitment as guarantor. You were not in the business of entering into contracts of guarantee. It is not considered that the provision of guarantees was undertaken by you as a regular and normal incident of your income earning activities.

Whilst it is acknowledged that you incurred interest expenses in relation to your previous company, such expenses do not sufficiently relate to your income earning activities. That is, the expenses belong to the company and you paid the expenditure on behalf of the company.

Therefore, any deduction for paying the company's debt will not be allowable under section 8-1 of the ITAA 1997 as it relates to the company's affairs and not your own assessable income.

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