Edited version of your private ruling

Authorisation Number: 1012441762758

Ruling

Subject: Interest expenses

Question

Are you entitled to a deduction for interest expenses?

Answer

No

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You formed a partnership with your spouse to purchase an investment.

You took out a loan in joint names.

You have since discovered that the investment was a scam.

You still have the outstanding loan to pay off.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 25-45

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for expenditure to the extent that it is incurred in the gaining or producing of assessable income, or in the carrying on of a business to gain or produce assessable income. No deduction is allowable to the extent that the expenditure is private, domestic or capital in nature.

Interest expenses fall for consideration under section 8-1 of ITAA 1997. The basic test for the deductibility of interest expenses is the use to which the borrowed funds are put. If borrowed funds are used to acquire income producing assets, the interest on these funds will generally be deductible (see TR 95/25 and TD 93/13).

In your case, although it was your intention to purchase an income producing asset, no asset was ever acquired and no income earning activity actually commenced. The money you received was not proceeds received from an income producing asset but simply funds received to perpetuate the fraud.

As such you are not entitled to a deduction under section 8-1 of the ITAA 1997.

Investment scam

Section 25-45 of the ITAA 1997 provides a deduction for a loss incurred by a taxpayer through theft, stealing, embezzlement, larceny, defalcation or misappropriation by an employee or agent of the taxpayer. The loss must be in respect of money which has been included in the taxpayer's assessable income and must be discovered in the income year in which the deduction is claimed.

You are not entitled to a deduction under section 25-45 of the ITAA 1997 for the interest incurred on the loan because the losses were not misappropriated or stolen by an agent or employee of yours.

If the loss caused by theft, stealing, etc is not deductible under section 25-45 of the ITAA 1997, it may still be deductible under section 8-1 of the ITAA 1997 provided the loss caused by the relevant criminal action represents that kind of casualty, mischance or misfortune which is a natural or recognised incident or a particular trade or business: Ash v. Federal Commissioner of Taxation (1938) 5 ATD 76; 61 CLR 263 per Rich J at p 277. However, the deduction under section 8-1 will only be available if the loss was necessarily incurred in carrying on a business.

Carrying on a business

The question of whether a business is being carried on is a question of fact and degree to be determined on a case by case basis. The courts have developed a series of indicators to determine the matter, which are summarised in Taxation Ruling TR 97/11. Although TR 97/11 specifically refers to primary production, the same principles apply to all businesses. Some indicators of carrying on a business which the courts have considered to be relevant include:

· whether the activity has a significant commercial purposes or character

· whether the taxpayer has more than just an intention to engage in business

· whether there is regularity and repetition of the activity

· whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

· whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

· the size, scale and permanency of the activity, and

· whether the activity is better described as a hobby, a form of recreation or sporting activity.

TR 97/11 states the indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' from looking at all the indicators and whether these factors provide the operations with a 'commercial flavour.

However, the weighting to be given to each indicator may vary from case to case, and no one indicator will be decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922).

To be carrying on a business, a taxpayer must be involved in the activities that make up that business. This would be evidenced by an element of control over, and/or an ongoing participation in, the business. The involvement should be direct or immediate, rather than passive. The payment of expenses relating to the ownership of property would not, without more, be sufficient. In the absence of such an involvement, an owner of property would not be regarded as being engaged in the business. The mere receipt by the property owner of a payment from users for the use of the item of property would be in the nature of income from property rather than from the carrying on of a business.

A taxpayer should undertake at least minimum activities necessary to maintain a commercial quantity and quality of product for sale. Although business owners do not necessarily have to manage the day-to-day operations themselves, it is expected that they would have control over the assets and business performance.

Application to your circumstances

You took out a loan to purchase an investment however you have since discovered that no investment existed. It cannot be said that you were carrying on a business; you had no control over any assets or ongoing participation in an activity with the characteristics referred to in TR 97/11 therefore no deduction is available under section 8-1 of the ITAA 1997 in relation to carrying on a business.

As you are not carrying on a business, Division 35 of the ITAA 1997 does not apply. Therefore the Commissioner is not required to address the non-commercial loss provisions.