Edited version of private advice

Authorisation Number: 1052331573943

Date of advice: 19 November 2024

Ruling

Subject: Deductions - trust claim for interest

Question

Can the trust claim a deduction for interest under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) on borrowings it proposes to use to pay down the credit loan balance of the primary beneficiary?

Answer

Yes.

This ruling applies for the following periods:

Year Ending 30 June 2025

Year Ending 30 June 2026

Year Ending 30 June 2027

Year Ending 30 June 2028

Year Ending 30 June 2029

Year Ending 30 June 2030

The scheme commenced on:

1 July 2024

Relevant facts and circumstances

The trust purchased a farming property (property A) prior to 20 September 1985.

In 20XX the trust purchased another farming property (property B).

Property B was purchased with funds from a bank.

Property B is being farmed by the trust.

The trust carries on business of primary production.

In September 20XX, the trust sold a portion of the Property A for a gain and distributed its net income for the 20XX income year and the gain made on the sale to the primary beneficiary.

Farm machinery and a shed were purchased using the funds from the sale to prepare the property for sowing with extensive weed control, mineral and fertiliser applications, fencing and land clearing.

The remaining amount after the purchase of the above assets was used to reduce the debt owed to the bank.

The trustee utilised the retained beneficiary's entitlements to:

•         Pay down the bank loan which was originally taken out to acquire the Bulla farming property,

•         Purchase various farming plant and equipment, and

•         Holding the balance for working capital purposes.

The primary beneficiary is one of several potential beneficiaries within the general beneficiary class under the deed, however, only he has received distributions from the trust in recent years.

The trustee wishes to payout the balance of the primary beneficiary's loan account. This balance is made up of unpaid net income and capital gain distributions.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the ITAA says that you can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

Whether the interest is deductible is related to whether the borrowed funds are incurred in gaining or producing the trust's assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing the trust's assessable income.

Taxation Ruling 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 (TR 95/25) 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, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

TR 95/25 however does not address deduction entitlements for trust. The Commissioner has since issued Taxation Ruling 2005/12 Income tax: deductibility of interest expenses incurred by trustees on funds borrowed in connection with the payment of distributions to beneficiaries (TR 2005/12).

Paragraph 7 of TR 2005/12 says that in order for the interest expense to be deductible, it must be sufficiently connected with the assessable income earning activity, or business, carried on by the trustee as trustee of a particular trust estate.

Paragraph 8 explains that the interest expenses will be sufficiently connected if the purpose of the trustee in borrowing funds, when viewed objectively, is to refinance a 'returnable amount'.

The term 'returnable amount' is used in TR 2005/12 to refer to money or property forming part of the trust estate that:

(a) is employed by the trustee in gaining or producing the assessable income of the trust estate, or in carrying on business for that purpose; and that

(b) a beneficiary of the trust estate is entitled to require to be returned to that beneficiary; and that

(c) is or represents money or property that was previously transferred by the beneficiary (or another person on the beneficiary's behalf) to the trustee of the trust estate, including money or property previously retained by the trustee out of funds to which the beneficiary was presently entitled.

Paragraph 9 of the TR 2005/12 provides the following factual situations to illustrate circumstances in which money or property is a returnable amount in the sense that that expression is used in this Ruling:

• an individual has subscribed money for units in a unit trust and has a right of redemption in relation to the units, and the money is used by the trustee to purchase income producing assets;
• a beneficiary has an unpaid present entitlement to some or all of the capital of a trust estate, or some or all of the net income of the trust estate, and the amount to which the beneficiary is entitled has been retained by the trustee and used in the gaining or producing of assessable income of the trust; and
• a beneficiary lends an amount to the trustee who uses the money for income producing purposes (for example, by depositing it at interest in a bank).

Application to your circumstance

In considering the term 'returnable amount' the trust meets the 3 requirements of paragraphs 5 of TR 2005/12 as the trustee has utilised the retained entitlements of the primary beneficiary to pay down the bank loan which was originally taken out to acquire property B and purchased various farming plant and equipment.

The borrowings are not to merely to discharge an obligation to make a distribution but connected to the gaining or producing of assessable income.

As the trust's proposed borrowing meets the definition of a returnable amount any interest incurred on the loan to repay this entitlement will be deductible under section 8-1 of the ITAA 1997.

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