Edited version of your written advice

Authorisation Number: 1012845018639

Date of advice: 23 July 2015

Ruling

Subject: Tax liability expenses

Question

Are you entitled to a deduction for your interest expense incurred on moneys borrowed to pay your tax?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commenced on

1 July 2014

Relevant facts

You had tax payable for the 2013-14 financial year. This was paid recently.

The tax payable was mainly a result of a capital gains tax (CGT) event as well as fully franked dividend income.

The CGT event was from the sale of your shares in your private company. The small business rollover option was chosen.

No actual CGT event proceeds were actually received in relation to the CGT event as the sale funds were reinvested in another non-related private company.

As you had no funds to pay your tax liability you borrowed funds. You incurred interest expenses.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Section 25-5.

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.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

• it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478), 

• there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

• it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Taxation Ruling TR 95/25 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 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, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. However, where a loan relates to private purposes, no deduction is allowed.

In your case, you have incurred interest expenses relating to the payment of your tax liability.

Subsection 25-5(1) of the ITAA 1997 allows a deduction for expenditure incurred in managing your tax affairs. However, paragraph 25-5(2)(c) of the ITAA 1997 specifically precludes a deduction under subsection 25-5(1) of the ITAA 1997 for expenses associated with borrowing money by an individual (including payments of interest) to pay a tax liability. Therefore your interest expenses incurred to pay your tax is not an allowable deduction under section 25-5 of the ITAA 1997.

In both Case V48 88 ATC 380 and Case 14/98 98 ATC 201, the taxpayer claimed a deduction for interest expenses on a loan and an overdraft (respectively) incurred to pay personal income tax bills. The Tribunal held that the payments of income tax were not made in gaining or producing assessable income, nor were they payments necessarily incurred in carrying on a business for the purpose of producing assessable income. Accordingly, the payments were not deductible.

It has generally been accepted that interest on a loan taken out to pay personal income tax is not deductible under section 8-1 of the ITAA 1997. However, where a business taxpayer borrows to pay income tax or pays the tax out of a larger loan taken out to meet general business expenses, the Commissioner does not generally disallow that part of the interest attributable to the payment of tax. Further, the Commissioner accepts that, where a business taxpayer borrows money to pay income tax, the interest incurred on those borrowings is deductible under section 8-1 of the ITAA 1997 provided the borrowings are connected with the carrying on of the business (Taxation Ruling IT 2582 Income tax : deductibility of interest incurred on moneys borrowed to pay income tax).

However, the Commissioner does not accept that interest is deductible in relation to payments of income tax which are not business-related. The payment of personal income tax is not an expense incurred in gaining or producing assessable income.

Even if the individual is a partner in a partnership, the payment of income tax lacks any direct connection with the business or income activities (Taxation Determination TD 2000/24 Income tax: are partners entitled to a deduction under section 8-1 for interest on borrowings to pay personal income tax?). It is acknowledged that your tax liability relates to the sale of shares in your private company and the receipt of dividends. However the nexus between the expense and your assessable income is too remote. The expense is not incurred in carrying on a business. As such, interest on borrowings to pay your tax liability is not an allowable deduction under section 8-1 of the ITAA 1997.

Please note, although paragraph 25-5(1)(c) of the ITAA 1997 specifically allows a deduction for the general interest charge or the shortfall interest charge, there is no provision that allows a deduction for your interest expenses incurred on borrowing money to pay your tax.