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Ruling

Subject: Interest deduction

Question:

Are you entitled to a deduction for the interest expenses incurred on the borrowed funds used to purchase units in a unit trust?
Answer:

Yes.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commenced on

1 July 2009

Relevant facts

You are an Australian resident.

You borrowed funds to purchase units in a unit trust.

You have several units. There are only two equal unit holders in the Trust.

The Trust has purchased land for development. There have been delays in the construction. The development should be completed in approximately three years time. The property will then be sold or leased upon completion.

You have not received any trust distributions as yet. You are expecting an income distribution during construction and a further distribution when the property is sold.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1.

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining

· assessable income or, in other words, of an income-producing expense

· (Lunney v. FC of T; (1958) 100 CLR 478,

· there must be a nexus between the outgoing and the assessable income so

· that the outgoing is incidental and relevant to the gaining of assessable

· income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47, and

· it is necessary to determine the connection between the particular outgoing

· and the operations or activities by which the taxpayer most directly gains or

· produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v.

· FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Taxation Ruling 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.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which assessable income is to be derived, the interest incurred on the loan will generally be deductible. 

The fact that a taxpayer does not derive any assessable income as a result of incurring the interest expenses to purchase units does not necessarily prevent a deduction as long as the incurring of the interest expenses is expected to produce assessable income.

Taxation Ruling IT 2684 considers the circumstances in which interest on money borrowed to acquire units in a property unit trust is an allowable deduction. All property unit trusts by their very nature have the potential to generate income, capital growth or both.

In the case of income units, which offer a return that consists wholly of assessable income or consists of assessable income with a very small percentage of capital growth, interest expenses incurred on borrowings used to purchase the units are generally deductible in full.

In the case of growth units, which primarily offer capital growth but also produce some assessable income, interest expenses incurred on borrowings used to purchase the units are deductible only up to the extent of the assessable income actually received.

In the case of combined units, which offer returns of both assessable income and capital growth, interest expenses incurred on borrowings used to purchase the units are generally deductible in full. The fact that an amount of capital growth may be received from units in a particular year is not considered sufficient to alter the essential character of the outgoing.

In your case, there is no evidence to show that you had another purpose or intention in acquiring the units other than to derive assessable income. It is considered that the expectation to gain or produce assessable income is reasonable. Therefore a deduction is allowable under section 8-1 of the ITAA 1997.