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Ruling

Subject: Deductibility of Interest expenses on property used for agistment

Question 1

Will the amount of interest (and other expenses) which is deductible be limited to the amount of agistment income you receive?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

You are currently a fly in/out mining employee.

You intend to purchase land with largely borrowed funds to commence a small scale livestock farming operation of approximately X acres.

If the activity is successful, you may increase the scale of your land holdings and activities.

You do not possess the necessary skills to undertake the activity yet so whilst you build up the necessary knowledge you intend to lease the property to other farmers in the area to agist their livestock. The current market rate for agistment is approximately $X per livestock per week.

Due to your current roster and the risk of undertaking farming, you intend to allow two weeks out of every six weeks for 1-2 years to gain to gain the knowledge required before purchasing your own livestock. You do not want to risk being unable to support your family whilst gaining the skills and knowledge required.

Your intended activity is to purchase and fatten livestock for sale into the meat market.

Initial research suggests that un-irrigated properties dependent on rainfall can hold approximately one livestock per X acres, whereas irrigated properties can clearly hold greater numbers.

The major expenses you expect to have are interest on monies borrowed to fund the purchase, rates and maintenance.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

You have advised that you intend to lease your property to farmers to allow them to agist their livestock and that you would seek to gain knowledge from these farmers to assist you to run your own livestock activity in the future.

The ordinary meaning of agistment is taking in and feeding or pasturing animals for a fee. Although your agreement may be termed a lease of rural property, according to the facts of the arrangement described it appears no different to pasturing animals for a fee and we consider that the leasing out of land for agistment purposes does not alter the fact that essentially the arrangement is an agistment arrangement.

Expenditure will be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) if it is incurred in gaining or producing assessable income unless it is of a capital, private or domestic nature.

It is necessary to consider the essential character of the expenditure incurred to determine whether there is a sufficient connection with the assessable income earned. The essential character of an expense is a question of fact to be determined by reference to all the circumstances.

Where expenditure is incurred, in part, for a purpose other than the production of assessable income the expenditure must be apportioned and a deduction allowed only to the extent that the expenditure was incurred for the income producing purpose.

The appropriate method of apportionment will depend on the facts of each case and the method must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 78 CLR 47; (1949) 8 ATC 431).

In Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher's case), the High Court suggested a 'commonsense' or 'practical' weighing of all the factors and in that case found that it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year. In Fletcher's case the assessable income derived from an annuity in each of the tax years was less than one-eighth of the relevant amount of interest outgoings in that year. The High Court accepted the Commissioner's position that the deduction for interest outgoings should be allowed to the extent of the assessable income received from the annuity investment plan.

Taxation Ruling TR 95/33 considers the implications of Fletcher's case and outlines the Commissioner's view on the importance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings. The ruling states that if an outgoing produces no assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure, including an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing, to determine whether the outgoing is wholly deductible. If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective, then the outgoing must be apportioned between the pursuit of assessable income and the other objective.

The Court took the view that if, on consideration of all those factors, the whole of the interest could be characterised as 'genuinely and not colourably incurred in gaining or producing assessable income', the interest would be fully deductible. If only part of the outgoing could be so characterised, apportionment between the pursuit of assessable income and of other objectives was necessary.

AAT Case 38/97 97 ATC 397; (1997) 36 ATR 1154 specifically dealt with the treatment of interest expenses incurred in relation to agistment income. In that case it was held that the outgoings to pay the interest on the loan to purchase the property were more properly characterised as an outgoing to maintain the asset base than to produce assessable income and that the Commissioner was correct in allowing a deduction to the extent of the income received from agistment.

Generally, the income from leasing a property for agistment purposes is disproportionate to the level of expenses incurred, particularly in cases where borrowed funds were used to purchase the property. This is not seen as a commercial arrangement, as it would usually take many years of income to recoup the expenses for even one year.

You state that you intend to purchase a property of approximately X acres which you intend to use for a dual purpose, that being agistment purposes and studying part-time (over one to two years) the business of fattening livestock. Your plan after one to two years is to carrying on a business of livestock fattening.

It is evident that you will not purchase the property merely for the purpose of gaining a small amount of assessable income from agistment, given the maximum carrying capacity of the property (unirrigated) would be X head (X acres with one beast per X acres). Using current agistment prices of $5.50 per head the maximum income from agistment would be $X (Xx $5.50 x 52 weeks).

In cases where a property is used for activities that lack a commercial character (that is, where income will rarely equate to the running costs of the property, such as an agistment activity), it is usual to apportion to allow expenses to the extent of income received.

A deduction for interest (and other expenses) incurred for the property would be allowed only to the extent of income received.