Edited version of private advice

Authorisation Number: 1051784033166

Date of advice: 26 November 2020

Ruling

Subject: Deductibility of interest on a loan from an external financier and on-lent to a family trust

Question 1

Will interest you are paid on a loan to a Family Trust, be included in your assessable income?

Answer

Yes

Question 2

Will the interest expense you incur on a loan from an external financier be deductible where the funds are on-lent to a Family Trust for investment purposes?

Answer

Yes, to the extent the on-lent funds provide assessable income to you.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You intend to borrow money from an external financier and on-lend the funds to a Family Trust (the Trust).

The on-lent funds will be used by the Trust for investment purposes.

You will enter into a loan agreement with the Trust stipulating that regular interest payments and capital repayments are made to you throughout the period of the loan.

You intend to match interest charged to the Trust with the interest rate set by the external financier on funds lent to you.

The loan to the Trust will be unsecured.

Money you borrow from the external financier and on-lent to the Trust will be secured against your property.

You are entering the on-lend financing agreement in order to secure finance for the Trust's investment activities at a lower interest rate than would otherwise be possible.

Relevant legislative provisions

Income Tax Assessment Act section 8-1

Income Tax Assessment Act section 6-5

Reasons for decision

Question 1

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Ordinary income has generally been held to include interest income and the general principle is that interest is derived when it is received or credited.

Interest payments received by you will form part of your assessable income in the income year they are received.

Question 2

Section 8-1 of the ITAA 1997 allows you a deduction for any loss or outgoing that is incurred in gaining or producing your assessable income, to the extent that it is not of a private, capital or domestic nature.

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.

A deduction will be permissible where a sufficient connection exists between the interest expense and the activities which produce assessable income. 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 interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income.

In your case, where amounts of interest incurred match interest payments received from the Trust for the income period, the amount will be deductible under section 8-1 of the ITAA 1997.

Apportionment

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, discusses the relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings.

Apportionment of an expense may be required in situations where there is a disproportion between the expenditure and the assessable income, and the disproportion is explained by a motive other than the gaining or producing of assessable income.

If an outgoing produces an amount of assessable income greater than the amount of the outgoing, there would normally be no need to examine the taxpayer's motives and intentions in characterising the outgoing as being deductible.

However, if the outgoing does not produce any assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure to determine whether the outgoing is wholly deductible. This may, depending on the circumstances of the particular case, include an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing.

In your case, one of the reasons for the on-lend arrangement with the external financier is to secure a lower interest rate for the Trust. Given this is primarily a private arrangement that is not connected with the objective of deriving your assessable income, it needs to be considered when accessing the deductibility of the interest expenditure incurred. As the loan to the trust is unsecured, you have some risk exposure to a future default or shortfall in interest payments. Consequently, the deductible amount for the interest expense you incur may need to be apportioned if necessary, to an amount that is no more than the interest income received from the Trust in any given year of income.