Edited version of private ruling

Authorisation Number: 1011771228200

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Ruling

Subject: Storm Financial collapse

Issue 1

Question and answer

Is the amount that you and your spouse believed to be a discrepancy that occurred when your home loans were amalgamated assessable income?

No.

This ruling applies for the following period:

Year ended 30 June 2009

The scheme commences on:

1 July 2008

Issue 2

Question and Answer

Is your share of the compensation amount treated as additional capital proceeds in respect of the disposal of your investments with Storm Financial Limited (Storm)?

Yes.

This ruling applies for the following periods:

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commences on:

1 July 2008

Issue 3

Questions and Answers

1. Is your share of the refund of unused prepaid interest assessable income?

No.

2. Are you entitled to a deduction in respect of your share of the interest paid?

Yes.

3. Is your share of the interest credited to you assessable income?

Yes.

4. Are you entitled to a deduction in respect of your share of the break costs?

Yes.

5. Are you entitled to a deduction in respect of your share of the dishonour charge?

Yes.

6. Is your share of the interest correction assessable income?

Yes.

This ruling applies for the following period:

Year ended 30 June 2009

The scheme commences on:

1 July 2008

Issue 4

Question and Answer

Are you entitled to a deduction for your share of the interest incurred in respect of your new home loan?

No.

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences on:

1 July 2008

Issue 5

Questions and Answers

1. Are you entitled to a deduction for your share of the administration fees incurred for prepaying the loans that were amalgamated?

Yes.

2. Are you entitled to a deduction for your share of the early repayment adjustment expenses incurred in respect of the previous loans that were amalgamated?

Yes.

This ruling applies for the following period:

Year ending 30 June 2009

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You and your spouse were clients of Storm and received financial advice from Storm.

On the advice of Storm and with their assistance, at various times you and your spouse applied, through Storm, for one or more home loans from a Bank in Australia(Bank) retail division.

At various times, the Bank's retail division approved home loan applications and advanced funds to you and your spouse under investment home loan A and investment home loan B (collectively the home loan). The home loan was secured by one or more registered mortgages over land.

The loans comprised of the following apportionments:

· Bank Account A:

o 100% for Storm investments.

· Bank Account B:

o a certain percentage for Storm Investments

o a certain percentage for rental property

o a certain percentage for private.

You and your spouse also held a Streamline e-Access Account - Account C - with the Bank.

Proceeds of the home loan were used from time to time by you and your spouse to purchase investments on the advice of Storm. The funds advanced under the home loan may have been combined with (i.e. geared through) a margin lending facility provided by a third party.

The investments may have included units in a Storm-badged index fund for which the responsible entity was a bank party.

Some time in the 2008-09 income year, the Bank amalgamated investment home loan A and investment home loan B into a non Storm related loan - Bank investment home loan D.

At the time of the amalgamation, certain amount were transferred from you and your spouses Streamline e-Access Account C into the accounts that were to be amalgamated. This resulted in the balance of Account D being a certain amount.

You and your spouse believed that the balance of the amalgamated loans (Account D) should have been a different amount and that the Bank had somehow incorrectly credited an amount to Account D.

As a result of the amalgamation, you and your spouse incurred an administration fee on each of the two loans in respect of the prepayment of the loans. You and your spouse also incurred early repayment adjustment expenses in respect of both accounts.

The returns generated by you and your spouses investments are no longer available to you and your spouse to apply towards meeting, or are insufficient to meet, repayment obligations under the home loan.

You and your spouse, either directly or through your solicitors, and the Bank have participated in a dispute resolution process known as the Storm Resolution Scheme (the scheme) on the terms set out in the Borrower Deed.

As a result of participating in the scheme, the parties have agreed upon:

(a) the release and waiver of an amount of indebtedness owned by you and your spouse to the bank; and/or

(b) the closure, variation or replacement of the current loan on the terms of the deed of settlement; and/or

(c) the payment of certain amounts to you and your spouse by the bank; and

(d) the releases which are set out in the deed of settlement.

You and your spouse's investment home loan D was released by a specified amount and was subsequently closed. A new Bank investment home loan Account E was approved. You and your spouse will incur interest on this loan at a variable rate in future years.

Part of you and your spouse's investments with Storm included a margin loan with Macquarie Bank Limited (Macquarie). 100% of this loan was used for Storm investments. Under the loan you and your spouse:

· received a refund of unused prepaid interest,

· received credit interest,

· incurred interest,

· incurred break costs,

· incurred a dishonour charge and

· incurred an interest correction amount.

You have provided copies of the following documents:

· the Bank Storm Resolution Scheme Deed of Settlement,

· the Macquarie Margin Lending statement,

· Storm Financial Index Share market Funds 2008/09 Tax Return Information Statements,

· Bank Home Loan Summary statements and

· Bank Streamline e-Access Account statement.

These documents form part of, and are to be read in conjunction with, your application for a private ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,
Income Tax Assessment Act 1997 Section 6-10,
Income Tax Assessment Act 1997 Section 8-1,
Income Tax Assessment Act 1997 Section 10-5,
Income Tax Assessment Act 1997 Section 20-25,
Income Tax Assessment Act 1997 Section 25-30,
Income Tax Assessment Act 1997 Section 102-20,
Income Tax Assessment Act 1997 Section 104-10,
Income Tax Assessment Act 1997 Section 104-25,
Income Tax Assessment Act 1997 Section 104-35,
Income Tax Assessment Act 1997 Section 104-55,
Income Tax Assessment Act 1997 Section 108-5,
Income Tax Assessment Act 1997 Section 109-5 and
Income Tax Assessment Act 1997 Section 116-20.

Reasons for decision

Issue 1

Is the amount that you believed to be a discrepancy that occurred when your home loans were amalgamated assessable income?

In order for an amount to be considered assessable income the amount in question must have been derived by a taxpayer.

The amount was transferred from you and your spouse's Streamline e-Access Account into your two home loan accounts prior to the amalgamation of these accounts. The amount was existing funds which already belonged to you and your spouse and was not income that you and your spouse derived. Accordingly, the amount is not assessable income.

Issue 2

Is your share of the compensation amount treated as additional capital proceeds in respect of the disposal of your investments with Storm Financial Limited (Storm)?

The general CGT provisions are set out in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997). Under the CGT provisions a taxpayer will make a capital gain or loss only if a CGT event happens.

To determine if a CGT event happens in respect of a compensation payment it is necessary to consider the nature of the asset to which the compensation payment relates.

The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 (capital gains: treatment of compensation receipts).

TR 95/35 states that the particular asset for which compensation has been received by the taxpayer may be:

· an underlying asset;

· a right to seek compensation; or

· a notional asset in terms of subsection 160M(7) - (section 104-155 of the ITAA 1997).

(TR 95/35 provides legislative references that relate to the Income Tax Assessment Act 1936). The equivalent provisions in the ITAA 1997 are cited where appropriate.)

In determining which is the most relevant asset it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt.

In TR 95/35 the term 'underlying asset' is used. The underlying asset is defined in TR 95/35 as:

the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

Taxation Ruling TR 97/3 also discusses compensation and deals with compensation received by landowners from public authorities. It explains at paragraph 2 that it extends the application of TR 95/35 and should be read in conjunction with that ruling.

Paragraphs 4 to 8 of TR 97/3 discuss the compensation received from a public authority for the compulsory acquisition of an easement and states that:

4. Compensation in respect of an easement created by statute in favour of a public authority cannot be said to have been received for the grant of the easement. The Land Acquisition (Just Terms Compensation) Act 1991 (NSW) and similar Acts in other jurisdictions enable public authorities to take land or an interest in land (including an easement) for specified purposes and confer on the affected landowner a right to compensation. In these circumstances, the landowner cannot be said to have created an asset as required for subsection 160M(6) of the Act (now includes 104-35 of the ITAA 1997) to apply. The easement is created by operation of the relevant statute and is vested in the public authority. This constitutes a compulsory acquisition of the easement.

5. The compensation received by a landowner from a public authority that compulsorily acquires an easement is not excluded from the scope of TR 95/35 by paragraph 2 of that Ruling which states that:

'This Ruling does not consider:

… amounts received for the grant of easements, profits a prendre and licences - these are covered in detail in Taxation Ruling IT 2561 and in Taxation Determinations TD 93/235 and TD 93/236'.

6. A strict application of Part IIIA would require the compensation received from a public authority to be treated as consideration in respect of the disposal by the landowner of the right to compensation. However, TR 95/35 focuses on the asset to which the compensation receipt most directly relates. In the case of easements acquired under statute and the consequential disposal of the right to compensation, the most relevant asset is the landowner's pre-existing land with its rights of ownership including, for example, a right to exclude all others. This right to exclude all others is forfeited in part when the easement comes into existence. The loss of part of this right constitutes the disposal of part of the underlying asset (the land) for Part IIIA purposes (paragraph 160M(3)(b) (now 104-25(1) of the ITAA 1997), subsection 160M(1) (now 104-10(2) and 109-5(1) of the ITAA 1997) and section 160R (now 108-5(2)(a) of the ITAA 1997).

7. Paragraph 4 of TR 95/35 states that:

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation.

8. Applying this approach, an amount of compensation received by a landowner for the loss of part of the rights of ownership is accepted as being consideration received in respect of the part disposal of the underlying asset (the land). The amount is not consideration for disposal of the right to seek compensation.

The ruling also considers a number of other circumstances when a landowner grants an easement on their land and in all but one instance the amount received is treated as consideration in respect of the part disposal of the land.

To the extent that the payment relates to the disposal of an underlying asset, CGT event A1 under section 104-10 of the ITAA 1997 happens.

This case:

You and your spouse were clients of Storm. You and your spouse applied and were granted home loans from the Bank's retail division. Proceeds of the home loans were used to acquire investments on the advice of Storm. These investments included a margin loan with Macquarie. The returns generated by these investments were no longer available to you and your spouse to apply towards meeting, or were insufficient to meet, repayment obligations under the home loan.

You and your spouse and/or with your solicitors have made a claim against the Bank for compensation concerning the circumstances surrounding the repayment of indebtedness under the home loans. The parties have reached a settlement. Under the settlement the parties have agreed upon a release of indebtedness totalling a specified amount along with the closure of the existing loan and approval of a new home loan. The release of indebtedness is considered to be compensation.

On the facts of this case, it is considered that the compensation received had a direct and substantial link with the underlying asset (the investments). Accordingly, in line with the guidelines provided in paragraph 4 of TR 95/35 and TR 97/3 it is considered that the compensation amount was received as part of the underlying asset and it was not received for the disposal of any other asset, such as the right to seek compensation. The amount is therefore accepted as consideration received for the disposal of the underlying assets and CGT event A1 in section 104-10 of the ITAA 1997 occurred when you and your spouse's investments were sold.

Please note that because you have received additional capital proceeds in respect of previous CGT events this may mean you will need to adjust any capital gains or capital losses that you included in the 2008-09 and 2009-10 income years.

Issue 3

Is your share of the refund of unused prepaid interest assessable income?

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or, in carrying on a business for the purpose of gaining or producing such income.

Where a taxpayer receives a refund of an item for which they have previous claimed a deduction, it is necessary to consider the character of the receipt in order to establish the taxation implications.

Section 6-5 of the ITAA 1997 provides that the assessable income of a resident taxpayer includes income according to ordinary concepts (ordinary income) derived directly or indirectly from all sources.

Relevant factors in determining whether a payment is ordinary income include:

· whether the payment is the product of any employment, services rendered, or any business;

· whether the payment is expected and relied upon;

· the character of the payment in the hands of the recipient;

· whether the payment is received as a lump sum or periodically; and

· the motive of the person making the payment, although this is rarely decisive by itself.

Section 6-10 of the ITAA 1997 provides that your assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision. A comprehensive listing of the relevant statutory provisions is specified in section 10-5 of the ITAA 1997. Included in this list are recoupments.

Division 20 of the ITAA 1997 operates to include a recouped amount as assessable income where the recoupment reverses the effect of previous income tax deductions in certain circumstances.

In your case, while the refund of prepaid interest fits the definition of a recoupment as defined in section 20-25 of the ITAA 1997, it is not assessable.

The refund of unused prepaid interest is not an assessable recoupment as it does not relate to a deduction for which recoupments become assessable.

The amount that you and your spouse received as a refund of unused prepaid interest does not fall within the concepts of either ordinary or statutory income. Therefore the amount will not be included as assessable income.

You may choose to amend your income tax assessment for the year ending 30 June 2008 to exclude any deduction you may have previously claimed in respect of the interest.

2. Are you entitled to a deduction in respect of your share of the interest paid?

The deductibility of interest on borrowed funds is determined by the use of the borrowed money. If the money is used to buy income producing assets, then the interest expense is an allowable deduction.

In FC of T v. Brown 99 ATC 4600, (1999) 43 ATR 1 (Browns case) the Full Federal Court held that a taxpayer may still be entitled to a deduction for recurrent interest expenses incurred after an income producing activity has ceased provided the occasion of the interest expense arose out of the taxpayers previous income earning activities. In Browns case, the Full Federal Court stated that the occasion for the recurring payments of interest was to be found in the original loan agreement (carrying with it the obligation to pay interest over the term of the loan) entered into by the taxpayer. The Full Federal Court found that the ceasing of the income producing activity did not operate to break this nexus.

However, the nexus between the interest expense and the relevant income earning activities will be broken where:

· the taxpayer has the ability to repay the loan but chooses not to do so, or

· the taxpayer makes a conscious decision to extend the loan in order to derive an ongoing commercial advantage unrelated to the prior income earning activities which resulted in the debt.

In your situation, you and your spouse borrowed funds to purchase investments. A nexus existed between the interest expense incurred and the assessable income earned. This nexus remains unbroken and therefore your share of the interest expense will be deductible under section 8-1 of the ITAA 1997.

3. Is your share of the interest credited to you assessable income?

Interest that you receive is assessable as ordinary income in accordance with 6-5 of the ITAA 1997. Therefore your share of the interest credited is required to be included in your assessable income.

4. Are you entitled to a deduction in respect of your share of the break costs?

Break costs are a form of penalty interest. Taxation Ruling TR 93/7 provides guidance on whether penalty interest payments are deductible. Penalty interest payment refers to an amount payable by a borrower under a loan agreement in consideration for the lender agreeing to accept an early repayment of a loan.

TR 93/7 provides that a penalty interest payment is generally deductible under section 8-1 of the ITAA 1997 if:

· the loan moneys were borrowed for the purpose of gaining or producing assessable income or for use in a business carried on for that purpose; and

· the payment is made in order to rid the taxpayer of a recurring obligation to pay interest on the loan, where such interest would itself have been deductible if incurred.

In your situation, the break costs were incurred on a loan that was purely for investment purposes. You and your spouse would have been entitled to deductions on the interest incurred in respect of this loan. Therefore your share of the amount that you and your spouse incurred in break costs is deductible under section 8-1 of the ITAA 1997.

5. Are you entitled to a deduction in respect of your share of the dishonour charge?

Similarly, to the break costs the dishonour charge was incurred by you and your spouse in respect of a loan that was purely for investment purposes. Accordingly, your share of the dishonour charge is deductible under section 8-1 of the ITAA 1997.

6. Is your share of the interest correction assessable income?

As previously stated, interest that you receive is assessable as ordinary income in accordance with 6-5 of the ITAA 1997. Therefore your share of the interest correction is required to be included in your assessable income.

Issue 4

Are you entitled to a deduction for your share of the interest incurred in respect of your new home loan?

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. TR 95/25 states that the deductibility of interest depends upon satisfying, or being able to show, that the expense has sufficient connection with the operations of activities which directly gain or produce a taxpayer's assessable income. In other words, the interest must be incurred in relation to property which is held for income producing purposes.

Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

On the basic of the decision of the Full Federal Court in FC of T V. Roberts; FC of T v Smith (1992) 37 FCR 246; 92 ATC 4380; (1992) 23 ATR 494 interest on a new loan will be deductible if the new loan is used to repay an existing loan which was being used for income producing purposes at the time the new loan was obtained. As the new loan has the same character as the existing loan, the interest on the new loan has the character of an income producing expenses.

Taxation Ruling TR 2000/2 provides the Commissioners view on the deductibility of interest on money drawn down under a line of credit facility. Any further borrowing under a line of credit facility represents new borrowings. Consequently, where the new funds are used for income producing purposes, for example, to purchase shares, the accrued interest expense is deductible under section 8-1 of the ITAA 1997. However if the further borrowing is used for private purposes, no deduction is allowed.

In your case, if you and your spouse were previously claiming deductions then these deductions would have been in respect of the margin loan through Macquarie. This margin loan is separate to the home loans that were entered into with Bank which have now been renegotiated into the new home loan. There is no nexus between the margin loan with Macquarie and the new home loan with the Bank. The new loan relates to you and your spouse's home loan only and this is considered to be for private purposes. Accordingly, you are not entitled to claim deductions under 8-1 of the ITAA 1997 in respect of your share of the interest incurred on the loan.

Issue 5

1) Are you entitled to a deduction for your share of the administration fees incurred for prepaying the loans that were amalgamated?

Section 25-30 of the ITAA 1997 allows a deduction for expenditure incurred to discharge a mortgage where the mortgage in given by the taxpayer as security for the repayment of money borrowed by the taxpayer and used by the taxpayer for the purpose of producing assessable income.

You and your spouse borrowed money to fund the acquisition of investments which were for the purpose of producing assessable income. You and your spouse's home loans under Account A and Account B were secured by a mortgage over land. As such, when these Accounts were amalgamated under Account D, you and your spouse effectively discharged the mortgages with regard to the loans. The administration fees that you and your spouse incurred at the time that the loans were amalgamated are therefore deductible under section 25-30 of the ITAA 1997.

2) Are you entitled to a deduction for your share of the early repayment adjustment expenses incurred in respect of the previous loans that were amalgamated?

The early repayment adjustment expenses that you and your spouse incurred are also a form of a penalty interest payment.

Where a borrowing is used to acquire an income producing asset and a penalty interest payment is made which effectively rids you of a recurring obligation to pay interest on the loan, the penalty interest payment is deductible under section 8-1 of the ITAA 1997.

You and your spouse incurred the early repayment adjustment expenses when your two home loans were amalgamated. The loans were for income producing purposes and the expenses were incurred to rid you of the obligation to pay interest under those particular loans. Accordingly you are entitled to a deduction for your share of the early repayment adjustment expenses incurred.