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Edited version of your written advice
Authorisation Number: 1012754931334
Ruling
Subject: Inheritance tax
Question and Answer:
Are you entitled to a deduction for the interest charged on the inheritance tax payable on a property in Country A which you will use for rental income purposes?
No
This ruling applies for the following periods
Year ended 30 June 2016
Year ended 30 June 2017
Year ended 30 June 2018
Year ended 30 June 2019
The scheme commenced on
1 July 2015
Relevant facts and circumstances
You are an Australian resident for tax purposes.
Your relative died in the 2013-14 income year.
You are the sole beneficiary of your relative's deceased estate.
You have inherited your relative's house in Country A and intend to rent it out. You will declare rental income in Australia.
The deceased estate has a Country A inheritance tax debt to pay under the Country A Inheritance Tax Act. You, as a beneficiary of the estate, are liable for paying the inheritance tax.
The inheritance tax is calculated on the value of the deceased estate.
The inheritance tax repayments are going to spread over n years. The tax will accrue interest over this period.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Tax deductibility of interest on inheritance tax
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 95/25, entitled, Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith, provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in the ruling, there must be a sufficient connection between the interest expense and the activities which produce assessable income. The ruling also specifies that interest on borrowed funds will not be deductible simply because it can be said to preserve assessable income producing assets.
Taxation Determination TD 2009/17 is entitled: Income tax: is interest on a loan fully deductible under section 8-1 of the Income Tax Assessment Act 1997 when the borrowed moneys are settled by the borrower on trust to benefit the borrower and others? The Taxation Determination states that the essential character of an interest expense derives from the purpose of the borrowing and the application or the use of the borrowed funds. The loss or outgoing is not deductible where it is incurred to gain or produce benefits for other persons.
Your case
In your case, the interest expense arises from an unpaid tax liability imposed on the deceased estate. You, as the beneficiary of the estate, are liable for the unpaid debt and ongoing interests on that debt.
The interest liability exists as you have decided not to pay the inheritance tax debt immediately. Therefore, the immediate purpose of incurring the interest is to delay the discharge of a tax debt.
Delaying the discharge of debt also allows you to retain the property as an income-earning asset. However, to have a sufficient connection for deductibility purposes, the incurring of the interest must have a purpose that goes beyond simply preserving the income-earning asset.
As the inheritance tax is calculated on the value of the deceased estate, the liability exists regardless of whether the property is rented, sold or kept for private use. The liability for interest on the inheritance tax is not dependent on the decision to use the asset as a rental property but would have been incurred had you decided, for example, to use the property as a private residence. Hence the purpose of the interest does not go beyond preserving the asset from which you will derive assessable income. Therefore, it cannot be said that there is a sufficient connection for deductibility purposes.
Furthermore, if you took out a loan to pay the inheritance tax in full, the interest expenses on that loan would still not be deductible. This is because the purpose and the use of the loan would be to pay the tax liability, rather than to gain or produce assessable income.
In conclusion, the incurring of the inheritance tax debt and interest on that debt has the essential character of a private expense arising under the Country A Inheritance Tax Act. The interest is not deductible.