Edited version of your written advice

Authorisation Number: 1051410965146

Date of advice: 7 August 2018

Ruling

Subject: Interest expenses

Question

Are you entitled to a deduction for any of the interest expenses where the interest is debited from the principal account held in another entity’s name?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 2019

The scheme commenced on

I July 2018

Relevant facts

You, your spouse, your relation and a Family Trust all have share investments.

You would like to consolidate investments in a joint margin loan. With your modest incomes you are unable to obtain a margin loan.

Entity A have advised you that they can set up a margin loan with a principal account in your relation’s name and sub-accounts for you, your spouse, a joint account for you and your spouse and the Family Trust. All funds in the loan facility relate to income producing share transactions.

The principal account holder would be responsible for payment of interest and costs of the principal account and sub-accounts. Interest for all margin lending accounts will be deducted from the principal account.

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, or relate to the earning of exempt income.

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 (Ronpibon’s case), 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).

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 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 incurred 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.

If the money is borrowed for the purpose of, or applied in, producing both assessable and non-assessable income, rather than producing only assessable income, the interest expense may need to be apportioned (see Ronpibon’s case at 59; 8 ATD 431 at 437; Kidston Goldmines Ltd v. FC of T 91 ATC 4538 at 4544-46; (1991) 22 ATR 168 at 175-177).

As a general rule, a loss or outgoing will not be deductible unless it is incurred in gaining or producing the assessable income of the taxpayer who incurs it (Federal Commissioner of Taxation v Munro (1926) 38 CLR 153) (1926) 32 ALR 339 (Munro's case).

You are a separate entity from your relation who is taxable in her own right.

It is a long standing principle that a taxpayer does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some casual connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred in gaining or producing your assessable income (Lunney’s case). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3.

Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out the Commissioner's views on the meaning of incurred. Generally, a taxpayer incurs an expense at the time they owe a present money debt that they cannot escape.

In this case, the interest expenses are being deducted from the principal account and therefore your relation is incurring the associated expenses.

Taxation Ruling TR 95/33 Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings considers various issues in determining the deductibility of losses and outgoings.

TR 95/33 requires an examination of all the circumstances surrounding the expenditure to ensure that the interest expense could be properly characterised as genuinely, and not colourably, incurred in gaining or producing assessable income.

If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective (for example, to derive exempt income or derive income for another entity or the obtaining of a tax deduction), then the outgoing must be apportioned between the pursuit of assessable income and the other objective: see Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613 (Fletcher’s case).

Income Tax Ruling IT 2167 Income Tax: rental properties - non-economic rental, holiday home, share of residence, etc. cases, family trust cases discusses arms-length arrangements with rental properties and relatives. Although your investments do not relate to rental properties, the principles in this ruling are relevant. The essential question in relation to arrangements with family members is whether the arrangements are consistent with normal commercial practices. If the arrangement is commercial, the owner of the property would be treated no differently for income tax purpose from any other owner in a comparable arms-length situation.

The test that should be considered to show whether the arrangement is at arm’s length, is whether a reasonable person with no relationship to either party would enter into this arrangement using exactly the same terms and conditions. If the answer is yes, then it would be an arm’s length and commercial arrangement.

Where a person lends money to a related entity or takes responsibility for their loan, a deduction for any interest or associated expense incurred will only be allowed where the arrangement is a commercial basis. There must be a reasonable expectation that the person will receive a return.

Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities.

The ruling establishes drawing any excess or available funds from the loan is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put. Where a person uses the redrawn funds for different purposes then the loan account becomes a mixed purpose account. In a mixed purpose loan, the interest must be apportioned between the income producing and non-income producing purposes. The part of the accrued interest attributable to the funds used for private purposes is not deductible.

You refer to paragraphs 6 and 12 of TR 2000/2. It is acknowledged that a line of credit facility may have a number of sub-accounts held by different borrowers and the associated interest may be deductible. However as further explained in paragraph 13 of TR 2000/2, the deductibility of accrued interest is determined by the application of the borrowed funds. It is acknowledged that the borrowed funds have been used for share investments, however in your circumstances, the sub-account holders are not accruing interest. As the sub-account holders are not accruing or incurring interest expenses under the margin loan facility, no deduction is allowable under section 8-1 of the ITAA 1997.

Some other loan facilities with sub-accounts have the sub-account holders as being liable for the interest expenses and the sub-account holders are responsible and incurring the associated interest expenses. However in your circumstances, you are not incurring any interest expenses and no interest is being debited from your sub-account, therefore no deduction is allowed.

In your case you intend to change your investment loans. The new margin loan will have a principal account in your relation’s name and sub-accounts in your name.

It is considered that the margin loan arrangement is not made on a commercial basis and that the arrangement is for some other purpose other than to produce assessable income for you. The purpose in the arrangement cannot be seen as characterising the expenditure as incurred solely in gaining or producing assessable income. The interest on this new margin loan is incurred by your relation. That is, you are not responsible for the payment of interest and costs of the loan. As you are not incurring any interest expenses, no deduction is allowed under section 8-1 of the ITAA 1997.