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Edited version of your written advice
Authorisation Number: 1012864597902
Date of advice: 27 August 2015
Ruling
Subject: Is interest deductible on a loan where the production of income has ceased
Question
Is interest incurred on borrowings which were originally used to fund the construction of the development deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) after the transfer of the development pursuant to the Family Court Order?
Answer
No
This ruling applies for the following periods
Year ended 30 June 2014
Year ended 30 June 2015
Year ending 30 June 2016
The scheme commenced on
1 July 2013
Relevant facts
The entity owned commercial property for a number of years.
The entity constructed a development on a block of land.
The entity obtained a loan to fund the development.
After completing construction of the development the entity retained it as an investment. The entity derived rental income from the property and incurred interest on its financing facilities. The entity has claimed a deduction for interest incurred.
A beneficiary of the entity and their spouse separated.
Both parties signed a consent order. As part of the consent order the development was to be transferred unencumbered to the spouse.
The entity rearranged the security of its loan to be covered by another asset owned by the entity.
The loan amount which financed the development remains on foot.
The entity has continued to incur interest on the loan since the transfer of the property.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Division 8 of the Income Tax Assessment Act 1997 (ITAA 1997) covers general deductions.
Subsection 8-1(1) of the ITAA 1997 states you can deduct from your assessable income any loss or outgoing to the extent that:
(a) It is incurred in gaining or producing your assessable income; or
(b) It is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
Subsection 8-1(2) of the ITAA 1997 states however you cannot deduct a loss or outgoing under this section to the extent that:
(a) It is a loss or outgoing of capital, or of a capital nature; or
(b) It is a loss or outgoing of a private or domestic nature; or
(c) It is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income or
(d) A provision of this Act prevents you from deducting it.
Taxation Ruling TR 2004/4 discusses deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities.
Paragraph 6 states the deductibility of interest is typically determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put (Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613, FC of T v. Energy Resources of Australia Limited 96 ATC 4536; 33 ATR 52, and Steele).
Paragraph 7 states ordinarily '...the purpose of the borrowing will be ascertained from the use to which the borrowed funds were put...' (Hill J in Kidston Goldmines Limited v. FC of T 91 ATC 4538 at 4545; (1991) 22 ATR 168 at 176). However, as his Honour later observed in FC of T v. JD Roberts; FC of T v. Smith 92 ATC 4380 at 4388; (1992) 23 ATR 494 at 504, '...a rigid tracing of funds will not always be necessary or appropriate...'.
Paragraph 10 states 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.
Paragraph 11 states 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.
Paragraph 12 states an outgoing of interest in such circumstances will not fail to be deductible merely because:
• the loan is not for a fixed term;
• the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty; or
• the original loan is refinanced, whether once or more than once.
Paragraph 13 states however, if the taxpayer:
• keeps the loan on foot for reasons unassociated 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.
In this case the entity transferred the title of an income-producing asset as part of a Court Order. The title was transferred unencumbered as the entity arranged the transfer of the security for the outstanding loan for the development to another income-producing asset which had increased in value which was also in the hands of the entity. The matter decided in the Family Court was purely a private matter between the beneficiary and the spouse and had no connection with the income-producing activities of the entity. By transferring the title of the development the entity settled a private matter of one of the beneficiaries and severed any nexus with the interest on the outstanding loan used to finance it.
It is therefore considered that the loan has been kept on foot for reasons unassociated with the former income-earning activities therefore the nexus between the outgoings of interest and the relevant income earning activities has been broken.
As the nexus has been broken the entity is not entitled to claim a deduction for the continuing interest incurred on the loan in relation to the development.