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Edited version of private advice
Authorisation Number: 1012637026230
Ruling
Subject: Investment interest
Question 1
Are you entitled to a deduction for the interest expense on your loan after the cessation of the business where no funds are available to repay the loan?
Answer
Yes.
This ruling applies for the following periods:
Year ended 30 June 2013
Year ending 30 June 2014
Year ending 30 June 2015
Year ending 30 June 2016
Year ending 30 June 2017
The scheme commences on:
1 July 2012
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.
The trust owns the shares in Company X.
Company X operates a mortgage lending business (the business).
You purchased a X% equity investment in the business.
You and your spouse took out a loan for the purchase.
The agreement was that you would receive X% of the profit and capital gains via a trust distribution.
At no time were you a director of Company X or the trustee company.
You do not own shares in either company.
You are not listed in the trust deed as a beneficiary.
The business was defaulting on their loan instalments and eventually the vendor placed a deed of surrender and release on the business.
All funds previously paid to the vendor were then forfeited by the trust as per the contract.
The companies and trust are in the process of being put into liquidation and are in no position to pay 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 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, or relate to the earning of exempt income.
Taxation Ruling TR 2004/4 deals with the deductibility of interest when it is incurred prior to or after the cessation of the relevant income earning activity.
Paragraphs 10 to 14 of TR 2004/4 state the following in respect of interest incurred after the cessation of the relevant income earning activity:
Where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period.
Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgment about the nexus between the outgoing and the income earning activities.
However, if the taxpayer:
• keeps the loan on foot for reasons un-associated with the former income earning activities; or
• makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred,
the nexus between the outgoings of interest and the relevant income earning activities will be broken.
A legal or economic inability to repay is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities.
In your case, you and your spouse took out a loan to purchase X% equity in the business. The business failed and you have forfeited the loan amount. The interest on the loan is held to be incurred or gaining or producing assessable income, and is deductible under section 8-1 of the ITAA 1997.