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Ruling
Subject: Interest expenses
Question:
Are you entitled to claim a deduction for interest incurred on a loan made to a discretionary trust of which you are a beneficiary?
Answer:
No.
This ruling applies for the following period
Year ended 30 June 2011
Year ended 30 June 2012
The scheme commenced on
1 July 2010
Relevant facts
You borrowed money from a financial institution in the 2010-11 financial year to loan to a discretionary trust of which you were a beneficiary.
Under the trust deed, the trustee has 'absolute discretion' to apply the trust income, in whole or in part as the trustee thinks fit, to all or one or more of the beneficiaries to the exclusion of the others.
The trustee of the trust also has the power to borrow monies under the trust deed.
The loan was to be used by the trust to purchase shares in a private company.
You expected to receive dividend income from the company as a beneficiary of the trust.
The company went into liquidation before any shares were issued to the trust.
You continue to incur interest on the loan.
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 a losses or outgoings to the extent that they are incurred in gaining or producing your assessable income, except where the losses or outgoings are of a capital, private or domestic nature.
Taxation Ruling TR 95/25 considers the deductibility of interest. 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.
In your case, the borrowed funds were loaned to a discretionary trust of which you are a beneficiary. In order to be entitled to a deduction for the interest you incur on the loan, you need to show that the expense was incurred in gaining or producing your assessable income from the trust.
Expenses incurred by beneficiaries of trusts, in relation to trust income, are not deductible unless it can be established that they were presently entitled to the trust income when the expenditure was incurred (Taxation Ruling IT 2385).
As the beneficiary of a discretionary trust, you are not presently entitled to any distribution from the trust until the trustee has exercised their discretion in your favour in any given income year. Until the discretion has been exercise, you have, at best, a mere expectancy of receiving income from the trust.
As no shares were issued to the trust and the company has been placed into liquidation, there is no possibility that the trust will produce any income from this investment that could be available for distribution to beneficiaries of the trust.
Where no income is available for distribution, the trustee cannot exercise their discretion in your favour and there is no nexus between the interest expense you are incurring and the gaining or producing of your assessable income from the trust. Therefore, you are not entitled to a deduction for the interest expenses you are incurring.
This approach is consistent with the decision in Case U144 87 ATC 318, where the taxpayer was a beneficiary of a discretionary family trust and was also a director of the corporate trustee of that trust. In his return for the 1983 year, the taxpayer disclosed as assessable income a distribution from the trust, and claimed as deductions various trust expenses which he had met personally, including bank interest.
The Tribunal held that the expenses were not deductible on the basis that a sufficient nexus had not been shown between the expenditure on behalf of the trust and the derivation of the taxpayer's assessable income.
While we appreciate your situation, there is no provision available that would allow you to claim these expenses in the circumstances you describe.