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Edited version of private advice
Authorisation Number: 1012648027149
Ruling
Subject: Interest
Question
Are you entitled to a deduction for the portion of interest that is not considered borrowing for capital protection?
Answer
Yes.
This ruling applies for the following periods
Year ending 30 June 2013
Year ending 30 June 2014
The scheme commences on
1 July 2012
Relevant facts and circumstances
You invested in a product. This product operates over a X year time frame.
There is an ability to continue this on or alternatively terminate and realise the existing value of the investment.
The key features are that this product:
• invests in the equities market via a geared structure
• there is a risk management overlay for this investment which reduces or increased expose to the market based on the underlying volatility
• the product pays a fixed coupon of Y% per annum for several years and an unlimited coupon for the final year reflecting the movement in the market
• an interest payment is payable in each of the years such that a gearing loss will occur in years one and two
The interest rate sits slightly above the borrowing rate for capital protection.
You accept that the portion above this rate is not deductible.
The product produces assessable income.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 8-1
Reasons for decision
Section 8-1 of the 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.
Generally, interest expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances.
Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, regard must be given to all the circumstances including the purpose of the borrowing and the use to which the borrowed funds are put.
Capital protected borrowing
A capital protected borrowing is essentially an arrangement where the borrower is protected for a decrease in the market value of an asset. The amount of interest reasonably attributable to capital protection is a capital cost that is not deductible.
Application to your circumstances
In this case, you have incurred interest in relation to your investment. A portion of this interest relates to capital protection and is therefore not deductible. However, the remaining interest expense has been incurred to produce assessable income and is therefore deductible under section 8-1 of the ITAA 1997.