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Ruling

Subject: Interest deductions - apportionment for non-income producing purpose

Question

Is the trust entitled to a deduction for the portion of interest incurred, calculated with reference to determining the balance of the income-producing portion of the line of credit as per the proposed method?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2012

Relevant facts and circumstances

X borrowed money from a family member for a private purpose.

A trust, of which X is the trustee, has also borrowed money from the family member for an income producing purpose.

X has been keeping track of the repayments to the family member by both X and the trust via a spreadsheet.

The proposed method

You propose to calculate the respective balances owing by X and the trust and the associated interest charges with reference to the following:

· Any repayments made by X will be applied solely to reduce the balance owing by X

· Any repayment made by the trust will be applied solely to reduce the balance owing by the trust

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. 

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. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed moneys is considered to be incurred in gaining or producing assessable income.

In this case, in essence what has occurred is X's family member has lent X and the trust money. Any repayment made by X will be considered to be a repayment of the funds borrowed from their family member for a private purpose. It is considered that the money borrowed by the trust was a separate loan with the same terms; therefore any payment made by X will not be required to be apportioned to the additional amount owing by the trust.

Accordingly, repayments made by X will reduce the amount borrowed for the private, non-income producing purpose. Similarly, any repayments made by the trust will be applied to the portion borrowed by the trust for income producing purposes.

As the trust used the borrowed funds for an income producing purpose, the trust will be entitled to a deduction for the interest attributable to the trust's portion of the loan.