Edited version of your written advice

Authorisation Number: 1051454195026

Date of advice: 13 November 2018

Ruling

Subject: Interest expenses – unit trust

Question

Are you entitled to a deduction for the interest incurred on funds borrowed to invest into a unit trust?

Answer

No.

This ruling applies for the following periods:

30 June 20XX

30 June 201XX

30 June 20XX

30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You borrowed $X to invest in units in a unit trust

The unit trust invested in a large land allotment

The intention was to hold the land until it was rezoned. Upon rezoning the land would be sold and you will receive a distribution of a capital gain based on your share of the units

No income was earned nor will it be earned from the property during the period of your ownership, only upon the realisation of the property itself

There is one class of unit holder

Under the Trust Deed you receive the right to receive distribution income and capital.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1936 section 51AAA

Income Tax Assessment Act 1997 section 110-25

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.

Whether interest has been incurred in the course of gaining or producing assessable income generally depends on the purpose of the borrowing and the use to which the borrowed funds are put.

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 (TR95/25) 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, regard must be given to all the circumstances including 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. The interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income. That is, it is generally accepted that interest incurred on funds borrowed to acquire an income producing asset is an allowable deduction.

Taxation Ruling IT 2684 Income tax: deductibility of interest on money borrowed to acquire units in a property unit trust (IT 2684) considers the circumstances in which interest on money borrowed to acquire units in a property unit trust is an allowable deduction. Paragraphs 15 and 36 of IT 2684 states:

15. If units in a property unit trust produce for a unitholder no assessable income in a particular income year, and there is no reasonable expectation that assessable income will be produced in the future, no amount of interest is deductible under subsection 51(1).

36. Additionally, in the case of units in a property unit trust which produce only capital growth, section 51AAA denies a deduction for any interest expense incurred on borrowed money to purchase the units.

The Commissioner’s view in IT 2684, with respect to capital growth split property units, is that where such units are expected to produce only negligible income, interest expenses incurred in borrowing money to purchase the units are deductible only up to the extent of the assessable income actually received.

In your case, you have not received any assessable income from the unit holding and you will only receive income upon the realisation of the property itself. Your intention and use of the borrowed funds was to derive capital income. The expenditure cannot be said to be incidental and relevant to gaining or producing your assessable income. Therefore the revenue expenses are not deductible under section 8-1 of the ITAA 1997. Section 51AAA of the Income Tax Assessment Act 1936 will also operate to specifically deny the deduction. It states that such expenses are not deductible by reason of the inclusion of a net capital gain as assessable income. The expenses may form part of the cost base for the CGT calculation. The third element of the cost base (section 110-25 ITAA 1997), adds into the cost base non-capital costs of ownership (for example, loan interest on borrowings).