Edited version of private advice

Authorisation Number: 1051792560709

Date of advice: 22 December 2020

Ruling

Subject: Interest deduction on funds borrowed to pay income tax

Question 1

Are you entitled to a deduction for interest incurred on money borrowed to pay income tax and PAYG instalment amounts that arise from you carrying on a business?

Answer

Yes

Question 2

Are you entitled to a deduction for interest incurred on money borrowed to pay your income tax liabilities that arise from your non-business income?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are a medical practitioner

You operate as a sole trader with your own ABN

You are registered for GST

You primarily receive PSI but do derive some employment income.

You primarily operate at a single location.

You pay fees for room hire, billing and secretarial services.

There is no contract between you and the locations you operate to earn PSI.

Equipment is provided at the locations where services are performed.

You receive payments directly from clients and health funds based on a fee for service.

You have full liability to rectify defects in your work and have indemnity insurance.

You have self-assessed that the PSI rules do not apply to you as you have met the results test.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-5.

Reasons for decision

Section 8-1 of the Income Tax Assessment Act (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or necessarily incurred in carrying on a business to gain or produce assessable income except where the outgoings are of a capital, private or domestic nature.

Subsection 25-5(1) of the ITAA 1997 allows a deduction for expenditure incurred in managing your tax affairs; however, paragraph 25-5(2)(c) specifically excludes a deduction under subsection 25-5(1) for expenses associated with borrowing money (including payments of interest) to pay a tax liability.

Taxation Ruling IT 2582 considers the deductibility of interest incurred on money borrowed by companies to pay income tax, and provides that where a taxpayer carries on a business for the purpose of gaining or producing assessable income and, in connection with the carrying on of that business, borrows money to pay income tax then it is considered that the interest incurred on those borrowings is a normal incident of conducting that business.

The same approach is applicable to an individual carrying on a business as a sole trader; however it does not apply to interest on borrowings that are not connected with the carrying on of a business for the purpose of producing assessable income.

ATO ID 2002/607, which considers the deductibility of interest expenses incurred on a loan taken out to pay the tax debt of an individual not carrying on a business, provides that the interest expenses are not deductible. The interest expenses are not deductible under section 8-1 of the ITAA 1997 as they are not incurred in earning assessable income as well as being private in nature, and they are not deductible under subsection 25-5(1) as they are specifically excluded by paragraph 25-5(2)(c).

You are able to self-assessed under the PSI rules and determined that PSI does not apply as you have met the results test. The fact that PSI rules do not apply is not enough to determine you are carrying on a business.

The Commissioner's view about carrying on a business is found in Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production (TR 97/11). The ruling lists the following indicators as being relevant when determining whether or not a business is being carried on:

•         whether the activity has a significant commercial purpose or character

•         whether the taxpayer has more than just an intention to engage in business

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

•         whether there is repetition and regularity of the activity

•         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit

•         the size scale and permanency of the activity

•         whether the activity is better described as a hobby, a form of recreation or a sporting activity.

Based on the above, you will be entitled to a deduction under section 8-1 of the ITAA 1997 for interest incurred on money borrowed to meet the income tax and PAYG instalment tax obligations that arise from your sole trader business. However, any interest incurred on money borrowed to pay your income tax liabilities that arise from non-business income, such as employment or investment income, will not be deductible under section 8-1 or subsection 25-5(1) of the ITAA 1997. As such, any interest incurred on money borrowed to pay your income liabilities that arise from both business and non-business income will need to be apportioned on a reasonable basis.