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Ruling

Subject: FBT - expense payment benefit and interest on investment loan

Question 1

Can the taxable value of the expense payment fringe benefit that arises from the payment or reimbursement of the interest on the Investment Loan incurred by employees be reduced under section 24 of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

Yes. However, the reduction under section 24 of the FBTAA does not extend to interest attributable to the cost of capital under Division 247 of the Income Tax Assessment Act 1997 (ITAA 1997)

Question 2

Will section 67 of the FBTAA apply to the employer in relation to the reimbursement of interest fees expenses of the arrangement?

Answer

No.

This ruling applies for the following periods:

Year ending 31 March 2012

Year ending 31 March 2013

The scheme commences on:

23 June 2011

Relevant facts and circumstances

Loans (Investment Loan) are provided to employees to fund their investment in a unit trust. The employees are Australian residents for taxation purposes.

The employer of the employees will make a payment in discharge, in whole or in part, of the obligation of the employees to pay the interest under the Investment Loan pursuant to a valid salary sacrifice arrangement.

In summary:

a) The investor will purchase units in a unit trust

b) There will be two classes of units that investors may choose between. Both classes will provide an exposure to Australian equities. One class will provide a positive return when Australian equities go up in value. The second class of units will provide a positive return when the Australian equities go down in value.

c) The term of the investment will be 12 months.

d) There will be no ability for investors to redeem or withdraw from the investment during the term

e) Both classes of units will pay distributions during the Term. These distributions will be paid approximately 10 months apart. The second distribution will be paid at maturity (along with any gain in relation to the class of unit's exposure)

f) At maturity both classes of units will return the capital initially invested.

g) Investors will be required to drawdown a loan of 100% of the investment amount in order to purchase the units in the trust.

h) The loan will be for the term of the investment and will be a limited recourse loan

i) Employees pay, via expense payment reimbursement, the entire term of 12 months interest expense on the Investment Loan.

j) Prepaid interest under the Investment Loan is in relation to a payment period of 12 months or less that ends on or before the last day of the income tax year.

The mechanics by which Employees are to be reimbursed the interest expenditure is as follows:

· The employee enters into a loan agreement with the loan provider, which creates an obligation for the employee to pay interest.

· The loan agreement requires the payment of interest annually in advance.

· On X July 20XX the employee incurs the following year's interest expense. The employee requests the employer to discharge the employee's payment obligation to the loan provider as part of their remuneration package. The employee is required to provide evidence to substantiate the interest liability and must complete an FBT declaration, confirming that a once-only deduction would have arisen for the employee in respect of the interest if it had not been the subject of the fringe benefit and that the employee will not claim a tax deduction for the interest expense in their tax return. The employer then makes a payment to discharge the employee's obligation under the loan agreement.

· The employer will reimburse employees in respect of 100% of the amounts of expenditure incurred by them on interest under their respective Investment Loans (where none of the interest is attributable to the cost of capital protection under Division 247 of the ITAA 1997).

· Any amount of a capital nature calculated under Division 247 of the ITAA 1997 is excluded from the amount that is reimbursed to employees.

· The fringe benefit is calculated in accordance with section 20 of the FBTAA.

· At the time that benefits are provided to employees, the employer or an associate of the employer, carry on the business of providing identical or similar benefits to members of the public, as it does to employees.

· The employer will either pay or reimburse the recipients portion, as an amount "otherwise deductible" to its relevant employees.

· The employer holds copies of the relevant declarations which substantiate the "otherwise deductible" claims.

Assumption

The Ruling is made on the basis of the following:

a) the dominant purpose of the employee in entering into the scheme is to derive assessable trust income;

b) the employees are not traders in investments and are not treated for taxation purposes as trading in interests in a trust, carrying on a business of investing in a trust, or holding their interests in a trust as trading stock or as a revenue asset;

c) all dealings between the employees and other entities will be at arm's length;

d) the Investment Loan will not extend beyond its original maturity date;

e) the employees will not repay the Investment Loan prior to their maturity or terminate the scheme early;

f) the unit trust is not a closely held trust and will have at least 300 unit holders and will be "widely held" for the purposes of section 272-105 of Schedule 2F of the ITAA 1936;

g) the employee enters into a valid salary sacrifice arrangement;

h) the employee will provide a valid Tax File Number.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 Section 20
Fringe Benefits Tax Assessment Act 1986 Section 22A
Fringe Benefits Tax Assessment Act 1986 Section 24
Fringe Benefits Tax Assessment Act 1986 Section 45
Fringe Benefits Tax Assessment Act 1986 Section 67
Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Division 247
Income Tax Assessment Act 1997 Section 247-20
Income Tax Assessment Act 1936 Subsection 51(1)
Income Tax Assessment Act 1936 Section 82KZL
Income Tax Assessment Act 1936 Section 82KZM
Income Tax Assessment Act 1936 Section 82KZMA
Income Tax Assessment Act 1936 Section 82KZME
Income Tax Assessment Act 1936 Section 82KZMF

Reasons for decision

Question 1

Expense Payments

Expense payment fringe benefits are considered in Part III, Division 5 of the FBTAA.

Section 20 of the FBTAA states that:

Where a person (in this section referred to as the "provider"):

c) makes a payment in discharge, in whole or in part, of an obligation of another person (in this section referred to as the "recipient") to pay an amount to a third person in respect of expenditure incurred by the recipient; or

d) reimburses another person (in this section also referred to as the "recipient"), in whole or in part, in respect of an amount of expenditure incurred by the recipient;

the making of the payment referred to in paragraph (a), or the reimbursement referred to in paragraph (b), shall be taken to constitute the provision of a benefit by the provider to the recipient.

The employer of the employees will make a payment in discharge, in whole or in part, of the obligation of the employees to pay the interest under the Investment Loan pursuant to a valid salary sacrifice arrangement. This meets the requirements of an expense payment benefit pursuant to section 20 of the FBTAA.

As explained under the heading of 'Deductibility of interest':

· In accordance with Taxation Ruling TR 95/33, the interest paid on a borrowing used to acquire income producing assets such as units in a trust is generally treated as deductible under section 8-1 of the ITAA 1997 where it is expected that assessable income would be derived from the investment.

· The employee's Put Option is a capital asset. As the cost of capital protection is the cost of the employee's Put Option, this expense is capital in nature. The interest incurred under an Investment Loan will be deductible under section 8-1 of the ITAA 1997 only to the extent that it is not the cost of capital protection.

Division 8 of the ITAA 1997 provides for deductions against your assessable income. Subsection 8-1(2) of the ITAA 1997 however, states:

… 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; …

As subsection 8-1(2) of the ITAA 1997 specifically excludes a loss or outgoing of a capital nature, where any portion of the interest on your employees' Investment Loan is attributable to the cost of capital protection, that portion is considered to be of a capital nature, and therefore not deductible.

The taxable value of an expense payment fringe benefit can be reduced, where it meets the conditions of the "Otherwise Deductible" rule detailed in section 24 of the FBTAA.

Subsection 24(1) of the FBTAA states:

Where:

(c) the recipient of an expense payment fringe benefit in relation to an employer in relation to a year of tax is an employee of the employer;

(d) if the recipient had, at the time when the recipients expenditure was incurred, incurred and paid unreimbursed expenditure … equal to:

(i) in the case of an in-house expense payment fringe benefit - the amount that, but for this subsection and Division 14 and the recipients contribution, would be the taxable value of the expense payment fringe benefit in relation to the year of tax; …

An 'in-house expense payment fringe benefit' is defined in subsection 136(1) of the FBTAA to mean:

(c) an in-house property expense payment fringe benefit; or

(d) an in-house residual expense payment fringe benefit.

In-house property expense payment fringe benefit

Subsection 136(1) of the FBTAA defines an 'in-house property expense payment fringe benefit':

In relation to an employer, means an expense payment fringe benefit in relation to the employer where:

(b) the recipients expenditure was incurred in respect of the provision of tangible property by a person (in this definition called the "property provider"); …

'Tangible property' as detailed in subsection 136(1) of the FBTAA:

Means goods and includes:

(b) animals, including fish; and

(c) gas and electricity.

The employer will provide its employees with the payment or reimbursement of their interest on a borrowing. As the payment or reimbursement is not tangible property, the benefit is not an in-house property expense payment fringe benefit.

In-house residual expense payment fringe benefit

Subsection 136(1) of the FBTAA defines an 'in-house residual expense payment fringe benefit':

In relation to an employer, means an expense payment fringe benefit in relation to the employer where:

(c) the recipients expenditure was incurred in respect of the provision of a residual benefit (other than a benefit provided under a contract of investment insurance) by a person (in this definition called the residual benefit provider);

(d) if the residual benefit provider is the employer or an associate of the employer - at or about the time that, if the residual benefit had been a residual fringe benefit, would have been the comparison time, the residual benefit provider carried on a business that consisted of or included the provision of identical or similar benefits principally to outsiders; …

The criteria for providing an 'in-house residual expense payment fringe benefit' are therefore:

· The employer must be a residual benefit provider, and

· At the time the employer provides the benefit to its employees, the employer or an associate of the employer must have carry on a business which provides a similar benefit to outsiders.

Is the employer a residual benefit provider?

A residual fringe benefit is defined in subsection 136(1) of the FBTAA to mean a benefit that is a benefit by virtue of section 45 of the FBTAA.

Section 45 of the FBTAA states that a benefit is a residual benefit:

… if the benefit is not a benefit by virtue of a provision of Subdivision A of Divisions 2 to 11 (inclusive).

A residual fringe benefit is therefore generally any fringe benefit that does not fall into one or more specific categories of a fringe benefit. The benefits that the employer will provide to employees are not considered within any of the specific fringe benefit categories, and are therefore considered residual benefits.

Does the employer or an associate of the employer carry on a business which provides similar benefit to outsiders?

At the time that the employer provides the benefit to its employees, the employer or an associate of the employer will carry on a business of providing identical or similar benefits to outsiders, as provide to the employees.

In-house residual expense payment fringe benefit summary

The payment or reimbursement by the employer of the interest on the investment loan incurred by its employees will be considered to be in-house residual expense payment fringe benefits as:

· The employer is a residual benefit provider; and

· At the time the employer provides the benefit to its employees, the employer or an associate of the employer will carry on a business which provides a similar benefit to outsiders.

Taxable Value of an in-house residual expense payment fringe benefit

The taxable value of an in-house residual expense payment fringe benefit is detailed in section 22A of the FBTAA. Subsection 22A(2) of the FBTAA states:

Subject to this Part, the taxable value in relation to a year of tax of an in-house residual expense payment fringe benefit (in this subsection called the "actual fringe benefit'') provided during the year of tax is the amount that, if:

(a) the provision of the residual benefit to which the actual fringe benefit relates were an in-house residual fringe benefit (in this subsection called the "notional fringe benefit''); and

(b) the recipients contribution in relation to the notional fringe benefit were equal to the recipients expenditure reduced by whichever of the following amounts is applicable:

(i) the amount of the payment referred to in paragraph 20(a) reduced by the amount of the recipients contribution in relation to the actual fringe benefit;

(ii) the amount of the reimbursement referred to in paragraph 20(b);

would have been calculated under whichever of sections 48 and 49 is applicable as the taxable value, but for section 52 and Division 14, of the notional fringe benefit in relation to the year of tax.

Under the arrangement, loans are made to employees. The fringe benefit relating to these loans is calculated in accordance with section 20 of the FBTAA, and to the extent that the amounts to be reimbursed exclude amounts of a capital nature, are "otherwise deductible". Specifically, you have excluded any amount of a capital nature calculated under Division 247 of the ITAA 1997 from being reimbursed to employees.

When considering the "otherwise deductibility" in reducing the taxable value of the benefits, paragraph 24(1)(ba) of the FBTAA states:

the amount (in this subsection called the "notional deduction") calculated in accordance with the formula:

GD - RD

Where:

GD is the gross deduction; and

RD is:

(i) if there is no recipients portion in relation to the expense payment fringe benefit - nil; or

(ii) if there is a recipients portion in relation to the expense payment fringe benefit - the amount (if any) that would, or would but for section 82A of the Income Tax Assessment Act 1936, and Divisions 28 and 900 of the Income Tax Assessment Act 1997, have been allowable as a once only deduction to the recipient under either of those Acts in respect of the recipients expenditure (assuming that any payment of that expenditure by the recipient at the time when the recipient's expenditure was incurred);

exceeds nil; and …

A recipient's portion is defined in subsection 136(1) of the FBTAA as:

in relation to an expense payment fringe benefit, means the recipients expenditure, reduced by whichever of the following amounts is applicable:

(c) the amount of the payment referred to in paragraph 20(a) reduced by the amount of recipients contribution;

(d) the amount of the reimbursement referred to in paragraph 20(b).

The employer will either pay or reimburse the recipient's portion, and therefore in either case, RD in the above formula will be nil, and the notional deduction, or amount otherwise deductible to the employee will be the amount the employer has paid or reimbursed to each employee.

Documentation

In cases where the otherwise deductible rule applies, certain documentation is required to be held by the employer. Paragraph 24(1)(e) of the FBTAA details the circumstances in which declarations need not be held. Cases involving the otherwise deductible rule are not listed, meaning that it is a requirement that:

The recipient gives to the employer, before the declaration date, a declaration, in a form approved by the Commissioner, in respect of the recipients expenditure.

The employer will hold the relevant employee declarations used to substantiate the expense payment as otherwise deductible to the relevant employees.

Summary

Expense payment fringe benefits are considered under Part III, Division 5 of the FBTAA. What constitutes an expense payment fringe benefit is detailed in section 20 of the FBTAA, while the taxable value of an in-house expense payment fringe benefit is determined under section 22A.

In certain circumstances, the taxable value of an expense payment fringe benefit can be reduced. One of those circumstances is where the otherwise deductible rule of subsection 24(1) of the FBTAA applies.

Where you apply the otherwise deductible rule, it is a requirement that you obtain documentation to support the employee's claim in the form of a declaration.

We have determined that:

· The payment to the loan provider by the employer or reimbursement by the employer of an employee's interest on the Investment Loan is an in-house expense payment fringe benefit.

· The taxable value of the in-house expense payment fringe benefit is reduced by the amount of interest which is "otherwise deductible" pursuant to section 24 of the FBTAA.

· The amount which is "otherwise deductible", which is paid by the employer or reimbursed by the employer, is the amount of the interest incurred on the investment loan by the employee other than interest attributable to the cost of capital protection under Division 247 of the ITAA 1997.

Deductibility of interest

Is the interest payable on the investment loan allowable as an income tax deduction to the employees in the absence of amount being reimbursed by the employer?

Section 8-1 and Division 247

Interest paid on a borrowing used to acquire income producing assets, such as units in a unit trust, is generally treated as deductible under section 8-1 where it is expected that assessable income would be derived from the investment (see Taxation Ruling TR 95/33 which relates to subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) which was the predecessor of section 8-1 of the ITAA 1997). Interest on an Investor's Investment Loan and, if applicable, the proportion of the interest incurred on the Interest and Put Protection Fee Loan that is used to pay interest on the Investment Loan, will be deductible under section 8-1 of the ITAA 1997.

The Put Option Interest, being the proportion of the interest on the Interest and Put Protection Fee Loan that corresponds to the part of the loan that is used to pay the Protection Fee, is not deductible under section 8-1.

Division 247 applies to the scheme as it is a capital protected borrowing (CPB). The Investor uses the Investment Loan to acquire an investment in the Trust and the Investor is wholly or partly protected against a fall in the market value of the investment. The investment in the Trust represents a beneficial interest in the unit trust.

Division 247 sets out a methodology for reasonably attributing the cost of capital protection incurred by a borrower under a CPB (section 247-20 of ITAA 1997). Division 247 ignores any amount which is not in substance for capital protection or interest, in calculating the cost of capital protection (subsection 247-20(3) of ITAA 1997).

Where a borrower enters into an Investment Loan, the amount reasonably attributable to capital protection, is worked out under the method statement in subsection 247-20(3) of ITAA 1997.

Under step 1 of the method statement, the Total Amount incurred by the Investor under or in respect of the CPB for the income year, includes the Protection Fee and interest incurred on the Investment Loan and the Interest and Put Protection Fee Loan (if applicable) for the income year.

Where the Total Amount incurred by the Investor worked out under step 1 of the method statement is less than the total interest that would have been incurred by the Investor worked out under step 2 of the method statement, there is no amount reasonably attributable to the cost of capital protection. In these circumstances, the interest on the Investment Loan and (if applicable) the proportion of the interest on the Interest and Put Protection Fee Loan that is not attributable to the Protection Fee will be deductible under section 8-1 of ITAA 1997.

Where the Total Amount incurred by the Investor is greater than the total interest that would have been incurred by the Investor worked out under step 2 of the method statement, the balance (the Excess Amount) is reasonably attributable to the cost of capital protection. In calculating the Additional Amount, the Excess Amount will be reduced by any actual payment for the Put Option (the Protection Fee) and the Put Option Interest in accordance with subsection 247-20(6) of ITAA 1997. The Additional Amount, to the extent that it is greater than zero, constitutes a further cost of capital protection in addition to the Protection Fee for the Put Option and the Put Option Interest. The Put Option is a capital asset for an Investor in the Trust. Therefore, the sum of the Protection Fee, Put Option Interest and Additional Amount (if any) is capital in nature and not deductible under section 8-1 of ITAA 1997.

Prepayments provisions

Subdivision H of Division 3 of Part III

Subdivision H of Division 3 of Part III of the ITAA 1936 deals with the timing of deductions for certain advance expenditure incurred under an agreement in return for the doing of a thing under that agreement that will not be wholly done within the same year of income. Separate rules apply depending on whether the expenditure is incurred in carrying on a business, whether the investor is a 'small business entity', whether the investor is an individual and whether the investor is not an individual and incurs the expenditure otherwise than in carrying on a business. This Subdivision does not apply to 'excluded expenditure', which is defined in subsection 82KZL(1) of the ITAA 1936 to include amounts of less than $1,000 or amounts of expenditure that are of a capital nature.

The eligible service period for the purposes of Subdivision H of Division 3 of Part III

The prepaid interest charges on the Investment Loan allowable under section 8-1 of the ITAA 1997 are in relation to a prepayment of loan interest for a period that is 12 months or less. Paragraph 82KZL(2)(a) of the ITAA 1936 provides that a payment of interest that is made in return for the making available of a loan principal is to be taken, for the purposes of Subdivision H of Division 3 of Part III of the ITAA 1936, to be expenditure incurred under an agreement in return for the doing of a thing under the agreement for the period to which the interest payment relates. The eligible service period in relation to a payment of loan interest is determined by reference to the period to which the interest relates, which is 12 months, and not to the period of the loan.

Sections 82KZME and 82KZMF - prepaid expenditure and 'tax shelter' arrangements

The rules in sections 82KZME and 82KZMF of the ITAA 1936 apply, subject to the exceptions in section 82KZME of the ITAA 1936, where expenditure is incurred in relation to a 'tax shelter' arrangement for the doing of a thing that is not to be wholly done within the expenditure year.

For the purposes of section 82KZME of the ITAA 1936, 'agreements' are broadly defined to include an entire arrangement of which a contract may form part. Under subsection 82KZME(4) of the ITAA 1936, the relevant 'agreement' is all the contractual arrangements and activities associated with the participation in a Fund, including the financing and management arrangements.

Exception 1, as contained in subsection 82KZME(5) of the ITAA 1936, applies to exclude the interest allowable under section 8-1 of the ITAA 1997 incurred on borrowings under the Investment Loan from the operation of section 82KZMF of the ITAA 1936 as:

· the documents and scheme described in the facts establish that investors have fixed entitlements to the income and capital of the Trust. Therefore, the prepaid interest allowable under section 8-1 of the ITAA 1997 is incurred in respect of money borrowed to acquire units in a widely held trust as described in subparagraph 82KZME(5)(b)(iii) of the ITAA 1936;

· the investor can reasonably expect to obtain trust income from the investment;

· the investor will not obtain any other kind of assessable income from the investment, except for capital gains; and

· all aspects of the scheme are at arm's length.

Section 82KZM - prepaid expenditure incurred by small business entities and individuals incurring non-business expenditure

Section 82KZM of the ITAA 1936 operates to spread over more than one income year a deduction for prepaid expenditure incurred by a taxpayer that is either:

· a small business entity for the year of income; or

· a taxpayer that is an individual and the expenditure is not incurred in carrying on a business.

The expenditure must not be excluded expenditure and must be incurred otherwise than in carrying on a business. Section 82KZM of the ITAA 1936 applies if the eligible service period for the expenditure is longer than 12 months, or the eligible service period for the expenditure is 12 months or shorter but ends after the last day of the year of income after the one in which the expenditure was incurred and the expenditure would otherwise be immediately deductible under section 8-1of the ITAA 1997.

As the eligible service period in relation to a deductible interest payment under an Investment Loan is no longer than 12 months and does not end after the last day of the year of income after the one in which the expenditure was incurred, section 82KZM of the ITAA 1936 will have no application to investors who are small business entities for the year of income, or to investors who are individuals and the expenditure is not incurred in carrying on a business. Employees who satisfy these tests will be able to claim an immediate deduction for the interest allowable under section 8-1 of the ITAA 1997 incurred under an Investment Loan.

Sections 82KZMA and 82KZMD - prepaid non-business expenditure incurred by non-individuals and non-small business entities

Sections 82KZMA and 82KZMD of the ITAA 1936 do not apply to set the amount and timing of deductions for expenditure for a taxpayer, to employees of the employer, as they are individuals and do not incur the expenditure in carrying on a business.

Question 2

Section 67 of the FBTAA is the general anti-avoidance provision of the FBTAA. In explaining the circumstances in which it is intended to apply the Explanatory Memorandum to the Fringe Benefits Tax Assessment Bill 1986 stated:

The clause is intended to apply where, on an objective view of a particular arrangement and its surrounding circumstances, it would be concluded that the arrangement was entered into for the sole or dominant purpose of having an amount omitted from an employers fringe benefits taxable amount of any year of tax in respect of a benefit provided to a person.

The circumstances in which the Commissioner can apply section 67 of the FBTAA are set out in paragraphs 67(1)(a) and (b) of the FBTAA which contain the following requirements:

· an employer obtains (or would have done so but for section 67 of the FBTAA) a tax benefit in respect of a year of tax

· the tax benefit was obtained in connection with an arrangement under which a benefit is or was provided to a person

· the arrangement was entered into, or commenced to be carried out on or after 19 September 1985, and

· one of the persons who entered into, or carried out the arrangement did so for the sole or dominant purpose of enabling the employer to obtain a tax benefit.

Subsections 67(2) and 67(3) of the FBTAA set out the circumstances in which a tax benefit will be deemed to have been provided.

Subsection 67(2) of the FBTAA provides that a tax benefit may arise where an amount that is not included in the employer's aggregate fringe benefits amount if that amount would have been, or could reasonably be expected to have been, included if the arrangement had not been entered into or carried out. The circumstances in which this will apply are limited by subsection 67(3) of the FBTAA which provides that a reduction in an employer's aggregate fringe benefits amount as a result of an employee contribution will not be a tax benefit.

The circumstances of this case are that under valid salary sacrifice arrangements the employees forgo salary in exchange for a fringe benefit in the form of payment of interest on an investment loan. It has been determined that the payment of interest would be deductible if it were expended by an employee, so the amount of the fringe benefit has been reduced under the otherwise deductible rule to potentially nil.

The resultant tax benefit to the employer is nil, i.e. if the arrangement had not taken place and the employee had paid the interest out of after tax dollars the employer would not pay any additional tax.

On an objective review of the transaction, it is concluded that the sole or dominant purpose in carrying out the arrangement does not constitute a purpose to purely obtain a tax benefit to the employer. 

It is concluded that section 67 of the FBTAA is not applicable to the arrangement.