Edited version of private advice

Authorisation Number: 1051710727660

Date of advice: 13 July 2020

Ruling

Subject: Interest deductions

Question

Are your interest expenses deductible?

Answer

No.

This ruling applies for the following period:

30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You own a business.

You are currently separated from your spouse and are finalising the asset allocation for your divorce.

You wish to purchase a business for your spouse worth approximately 50% of your current business, prior to finalising the divorce.

This purchase would be 100% financed with a loan.

You intend on retaining your current business and taking on the loan for the new business.

You will have no involvement in the new business.

The outcome of taking on the loan would result in your asset value in the marriage being equal to your spouse's asset value.

You wish to claim the interest on the loan as a business deduction as it would a direct result of purchasing your spouse's business.

The reason you believe this interest should be deductible is that if you were not divorcing, the loan interest would be claimable in the new business for both you and your spouse.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Deductibility of interest expenses

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows you a deduction for any loss or outgoing that is incurred in gaining or producing your assessable income, to the extent that it is not of a private, capital or domestic nature.

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. There must be a sufficient connection between the interest expense and the activities which produce assessable income to claim a deduction. To determine whether the associated interest expenses are deductible, it is necessary to examine 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 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for business or investment purposes from which income is to be derived, the interest expense incurred on the loan will be deductible.

In your case, you are entering a loan to purchase a business for your spouse prior to divorce. This loan will be in your name and you will not be connected with the business. The result of entering into this loan is to 'pay out' your spouse's share in your current business in order to even up asset allocation prior to divorce.

You contend that if you and your spouse were not divorcing, and entered into a loan for a new business, the interest amounts would be a claimable expense in the business. In this scenario, the interest deductions would in fact be claimable as they would meet the deductibility criteria.

As the new business will be owned and run by your spouse without your connection, your spouse will not be required to pay the loan and the loan will not affect the income producing aspect of the new business. There will be no connection between the loan and an income producing activity.

On these grounds, the Commissioner will not allow the interest on the loan to be a claimable deduction under section 8-1 of the ITAA 1997.

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