Edited version of your written advice

Authorisation Number: 1051291557275

Date of advice: 6 October 2017

Ruling

Subject: Deductibility of business and legal expenses

Question 1

Are you as the beneficiary of a trust in a partnership entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 for a payment made in respect of expenses incurred in relation to partnership income?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

The scheme commences on:

1 July 2016

Relevant facts and circumstances

You are the beneficiary of a trust operating a business in partnership with other another trust.

The partnership entered into a credit agreement and you agreed to act as guarantor for the obligations of the partnership and any costs incurred by the creditor in connection with recovering payment under the terms of the agreement.

You made a payment in your capacity as guarantor under the terms of the credit agreement.

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, relate to the earning of exempt income or are excluded by another provision of the taxation legislation.

The courts have considered the meaning of 'incurred in gaining or producing assessable income'. In Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 56 ALR 785; (1949) 8 ATD 431 the High Court stated that:

For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income.

The reference to your assessable income in section 8-1 of the ITAA 1997 means that the expenditure must be incurred in producing the assessable income of the person who incurs the expenditure.

Generally, a taxpayer cannot claim a deduction unless it is incurred in gaining or producing their assessable income. Only the person who incurs the expense can claim the deduction, but it has to relate to assessable income that they have derived.

As stated in Case M36 80 ATC 280 (Case M36):

It is a condition of deductibility under section [8-1 of the ITAA 1997] that any loss or outgoing must have a nexus with the gaining or producing of assessable income in the hands of the claimant, or be necessarily incurred in carrying on a business (by the claimant) for the purpose of producing such income.

All losses and outgoings of a taxpayer incurred in gaining or producing assessable income of the same taxpayer are allowable deductions to that taxpayer and only that taxpayer: Marshall Richards Machine Co Ltd v Jewitt (1956) 36 TC 511.

In practice, taxpayers often have to deal with groups of related companies or entities.

Taxpayers must bear in mind that each entity is a separate taxpayer, and that generally a loss or outgoing will not be deductible under section 8-1 of the ITAA 1997 unless it is incurred in gaining or producing assessable income (or in carrying on a business for the purpose of gaining or producing such income) for the taxpayer who incurred that loss or outgoing: Federal Commissioner of Taxation v Munro (1926) 38 CLR 153 at 170 per Knox CJ.

Consequently you are not entitled to a deduction as there is an insufficient nexus between the business and legal expenses of the partnership and the earning of your assessable income.