Edited version of private ruling

Authorisation Number: 1011796515593

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Ruling

Subject: Storm financial collapse

Issue 1

Question 1

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

Answer: No.

Question 2

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

Answer: Yes.

Question 3

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

Answer: Yes.

Question 4

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

Answer: Yes.

Question 5

Is your share of the interest correction assessable income?

Answer: Yes.

Question 6

Are you entitled to a deduction in respect of your share of the early repayment costs?

Answer: Yes.

Question 7

Are you entitled to a deduction in respect of your share of the early repayment admin fee?

Answer: Yes.

Question 8

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

Answer: Yes.

Issue 2

Question 1

Are you entitled to a deduction for your share of the interest incurred in respect of your loan where 100% of the proceeds were used to repay your joint loan account?

Answer: Yes.

This ruling applies for the following periods:

Year ended 30 June 2009

Year ended 30 June 2011

Year ended 30 June 2012

Relevant facts and circumstances

You and another were clients of Storm Investments.

To facilitate your investments you opened a margin lending loan account of which 100% was used for Storm Investments. Under the loan you:

· received a refund of unused prepaid interest,

· incurred interest,

· received credit interest,

· incurred break costs,

· received an interest correction amount.

You also opened a joint loan account, of which 100% was used for Storm Investments. Under the loan you:

· incurred early repayment costs,

· incurred an early repayment fee admin fee,

· incurred interest.

You opened another loan account, of which 100% of the drawdown was used to repay your joint loan account.

Your Storm investments were withdrawn completely by 18 November 2008.

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 and

Income Tax Assessment Act 1997 Section 20-25.

Reasons for decision

These reasons for decision accompany the Notice of private ruling.

Issue 1 Question 1

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent that 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 of prepaid interest received as a refund 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.

Issue 1 Question 2

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 Federal Commissioner of Taxation v. Brown 99 ATC 4600; [1999] FCA 721 (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 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.

Issue 1 Question 3

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

Issue 1 Question 4

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 would have been entitled to deductions on the interest incurred in respect of this loan. Therefore your share of the amount incurred in break costs is deductible under section 8-1 of the ITAA 1997.

Issue 1 Question 5

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 1 Question 6

As previously stated early repayment costs (previously called break costs) are a form of penalty interest. In your situation, the early repayment costs were incurred on a loan that was purely for investment purposes. You and Mr Carlin would have been entitled to deductions on the interest incurred in respect of this loan. Therefore your share of the amount incurred in early repayment costs is deductible under section 8-1 of the ITAA 1997.

Issue 1 Question 7

Bank fees on loans are deductible under section 8-1 of the ITAA 1997, provided that the fees are incurred on a loan that was used purely for investment purposes.

In your case the early repayment admin fee is regarded as a type of bank fee. Accordingly you are entitled to a deduction for your share of the early repayment admin fee under section 8-1 of the ITAA 1997.

Issue 1 Question 8

As previously stated 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.

Again, the decision in Browns case allows that recurrent interest expense incurred after an income producing activity has ceased are deductible, provided the occasion of the interest expense arose out of the taxpayers previous income earning activities.

In your situation, you 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.

Issue 2 Question 1

Again, 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 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. In Federal Commissioner of Taxation v. Jones 2002 ATC 4135; (2002) 117 FCR 95 the full federal court found that the refinancing of a business loan after cessation of the business activities to obtain a better interest rate did not break the nexus between the interest expense and the business. The court considered that the new financing takes on the same character as the original borrowing.

In your situation, you repaid your investment loan with 100% of funds raised from another loan. Further advances have not been made from this second loan. A nexus existed between the interest expense incurred and the assessable income earned in respect to your investment loan. This nexus remains unbroken when you refinanced, and therefore your share of the interest expense will be deductible under section 8-1 of the ITAA 1997.