Edited version of your private ruling

Authorisation Number: 1012442869652

Ruling

Subject: Income - Interest expenses and penalty interest deductions

Question and Answers

1. Are you entitled to a partial deduction for interest expenses in relation to agistment?

Yes.

2. Are you entitled to a partial deduction for interest for the period the property was vacant between tenancies?

Yes.

3. Are the expenses claimable against agistment income limited to the amount of agistment income received?

Yes.

4. Are you entitled to a deduction for penalty interest for the early payment of a loan?

No.

This ruling applies for the following periods

On or after 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 acquired a property.

You acquired the property to conduct development and mining.

At the time of purchase the land was under lease for agistment.

The total sale price was loaned to you by a lender.

You were not an employee of the lender.

The loan was personally guaranteed by you.

The loan was unsecured.

The condition of the loan is that it should be used for the purchase of the property only and the tenure of the loan is for a period of X years.

If the loan is paid during the agreed tenure of the loan you will be responsible for the interest for the remaining period of the loan.

For a period 100% of the land was given to gain agistment income.

For a short period the property was not agisted.

Then the property was used for agistment again.

The responsibility of the management, maintenance and care of the animals belonged to the stockowner and not you.

The property was sold.

The total amount due to the lender has been paid in full.

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.

Agistment

Agistment income is assessable income according to ordinary concepts. Taxation Ruling IT225 discusses agistment income.

Paragraph 4 of the ruling indicates that if the property or a substantial part of a property is used solely for agistment, this may not amount to carrying on a business.

In the AAT case 10,331 (1995) 31 ATR 1146, Senior Member Fayle said at 1152-53:

Agisting another's livestock does not ordinarily constitute the carrying on of a business. Agistment fees ordinarily are in the nature of rent. However, where a land owner is charged with the management, maintenance and care of the animals agisted then it is possible that the person is carrying on a business, the reward for which is the agistment fee. This is more likely if the level of the agistment fee depended upon the effective management, maintenance and care of the animals.

In Case 38/97 36 ATR 1154; 97 ATC 397 the taxpayer, a husband and wife, purchased, largely with borrowed funds, a 16 hectare farm near Cairns in Queensland. At the time of purchase, the taxpayers intended to improve the property and, as soon as they could afford to do so, to purchase cattle for fattening. In due course they also hoped to live on the property.

The taxpayers carried out improvements to the property, such as fencing, and used the property for the agistment of cattle owned by a neighbouring farmer. The deductions the taxpayers claimed during the period in question totalled over $78,000 (largely being interest on the loan used to acquire the property), while the income earned from the agistment activities during the same period was less than $6,000.

The Administrative Appeals Tribunal held that the taxpayers were not engaged in the business of agistment. The Tribunal also held that there were two purposes in holding the property: the generation of income and its value as an asset. Therefore, the taxpayers' deductions were limited to the extent of the assessable income received.

In application to your case, the only activity conducted on your property was the agistment of another party's cattle. You did not maintain animals for the purpose of selling them or their bodily produce (including natural increase). You merely leased out your property to another party who maintained the animals. The activity is analogous to a passive investment activity. There was no other activity conducted on the property.

Consequently, you are entitled to a deduction for interest expenses in relation to agistment but the interest expenses you may claim, as a deduction in relation to this activity, are limited to the income you derived from the activity.

Interest expenses and vacant property

In Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele's Case), the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production.

It follows from Steele's Case that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances:

· the interest is not incurred 'too soon', is not preliminary to the income earning activities and is not a prelude to those activities

· the interest is not private or domestic

· the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost

· the interest is incurred with one end in view, the gaining or producing of assessable income, and

· continuing efforts are undertaken in pursuit of that end.

You acquired the property and at the time of purchase the land was under lease for agistment which you inherited on purchase.

For a very short period the property was untenanted; after which it was again tenanted for agistment.

Consequently the interest was not incurred 'too soon', the period of interest outgoings prior to the derivation of relevant assessable income is not too long that the necessary connection between outgoings and assessable income has not been lost and the interest was incurred with one end in view, the gaining or producing of assessable income.

Therefore, you are entitled to a deduction for interest expenses in the period the property was vacant but limited to the income you derived from the activity.

Penalty Interest

Taxation Ruling TR 93/7 provides guidance in determining whether penalty interest payments are deductible.  

TR 93/7 makes the following statements:

A penalty interest payment is generally deductible if:

(a) The loan moneys were borrowed for the purpose of gaining or producing assessable income; and

(b) The payment is made in order to rid the taxpayer of a recurring obligation to pay interest on the loan, where such interest would itself have been deductible if incurred.

Penalty interest is not expenditure incurred in borrowing money. It is a cost attributable to obtaining early repayment of a loan. In order to establish if the penalty interest is on capital or revenue account, the question to be asked is what is the advantage sought from early payment of the loan. 

Where the penalty interest payment is paid effectively as a price to rid a taxpayer of a burdensome capital asset or is otherwise incidental to the realisation of an asset, then it will generally be on capital account.

You incurred the penalty interest to disencumber yourself of the debt, and as such the expense is capital in nature and not deductible under section 8-1 of the ITAA 1997.