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This edited version has been archived due to the length of time since original publication.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.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1012862962629

Date of advice: 19 August 2015

Ruling

Subject: Interest expense

Question

Are you entitled to a deduction for interest expense on the dual loan facility for the years ended 30 June 20YY to 30 June 20ZZ?

Answer

No.

This ruling applies for the following periods

Year ending 30 June 2016
Year ending 30 June 2017
Year ending 30 June 2018
Year ending 30 June 2019
Year ending 30 June 2020
Year ending 30 June 2021

The scheme commences on

1 July 2015

Relevant facts and circumstances

You purchased a property from a third party.

You intend to use this property for the purpose of gaining or producing assessable income and have entered into a tenancy agreement to lease this property.

You financed this purchase with a loan by way of mortgage for a percentage of the property value, over a X year term with principal and interest payable on a monthly basis.

You have also set up a mortgage offset account connected to this loan. This offset account does not reduce any indebtedness to the mortgagor, but no interest is chargeable by the mortgagor on an amount of the mortgage corresponding with the balance in the offset account.

You can redraw funds at any time from this offset account without penalty and you state that you will take advantage of this redraw facility from time to time. In order for you to facilitate this property purchase and the mortgage you needed to have available funds to cover all other expenses in relation to this purchase, being, though not limited to:

You procured these additional funds by way of loans from an relative under connected loan agreements.

Features of the loans are:

You state that the loans will pass to the lender's testamentary beneficiaries with no provision for forgiveness on the death of the testator.

A private ruling was issued stating that the interest incurred on both loans was not deductible as the arrangement was private in nature. The Commissioner did not accept that the interest was being genuinely incurred.

The ruling's reasons for decision stated that several factors of the loan agreements appeared to be non-commercial in character, for example:

Additionally there were concerns in relation to:

You have used the balance of the funds to assist in purchasing another property. This property will be used to earn assessable income.

You entered into an Amending Deed with your grandparent, effective from the 2015-16 financial year.

The Amending Deed amended the loan agreements to:

The purpose of the Amending Deed was to address issues including:

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1
Taxation Administration Act 1953 Schedule 1 Section 359-35

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 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.

Where a person borrows money from a related entity, a deduction for any interest expense incurred will only be allowed where the money is borrowed on a commercial basis, irrespective of how the borrowed funds have been used.

The test that should be considered to show whether the arrangement is at arm's length, is whether a reasonable person with no relationship to either party would enter into the arrangement using exactly the same terms and conditions. If the answer is yes, then it would be an arm's length and commercial arrangement.

In the reasons for decision accompanying the previous private ruling it was stated that several factors of the loan agreements appeared to be non-commercial in character, for example:

Since receiving the ruling you have entered into an Amendment Deed to:

The creation of the Amending Deed supports the Commissioner's view of the non-commerciality of the arrangement between yourself and your relative. It would be unusual for an unrelated party to vary a loan arrangement in such a significant manner after the borrower had received an unfavourable ruling from the ATO. The variation supports the view that the loan can be easily changed by you when circumstances which make it advantageous to do so arise.

As the dual loan facility is considered to be non-commercial in nature, the Commissioner does not have certainty that the terms and conditions of the loan including the payment of interest will be met.

Therefore no deduction is allowable for interest expenses incurred under the loan facility.

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