Edited version of private advice

Authorisation Number: 1051852332472

Date of advice: 23 June 2021

Ruling

Subject: Deductibility of break costs

Question 1

Are Break Costs comprising of interest foregone and administration fees deductible under section 8-1(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are Break Costs comprising of interest foregone and administration fees deductible under section 25-30 of the TAA 1997?

Answer

Yes

This ruling applies for the following period:

30 June 20XX

The scheme commences on:

30 June 20XX

Relevant facts and circumstances

The Taxpayer acquired ASX listed shares during 20XX to 20XX income years.

The Taxpayer acquired the shares solely to produce assessable income, by way of dividend income and capital gains following the disposal of the shares.

The Taxpayer entered into Margin Loans with the Lender in order to finance the acquisition of shares. The Lender registered security interest against the Taxpayer. The security interest was withdrawn when the Margin Loans were paid.

In order to avoid interest cost expenses, the Taxpayer disposed of the shares and terminated all of the Margin Loans in the 20XX income year.

As a result of the early termination, the Taxpayer incurred break costs under the Margin Loans agreements.

The Taxpayer considered that, on balance, it was preferable to realise the profits and pay the break costs rather than continue paying interest.

The Lender charged Break Costs to the Taxpayer of $XXXX comprising of:

a.            Interest foregone by the Lender due to voluntary termination in the amount of $X;

b.            Administration fee - 15 x Loan closures in the total amount of $X; and

c.             Administration fee - 1 x PPSR Discharge in the amount of $X

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-30

Reasons for decision

Question 1

Are Break Costs comprising of interest foregone and administration fees deductible under section 8-1(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes

Detailed reasoning

Section 8-1 of the ITAA 1997 relevantly provides that:

S8-1(1)

You can deduct from your assessable income any loss or outgoing to the extent that:

(a)          it is incurred in gaining or producing your assessable income; or

(b)          it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Note:

Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income.

S8-1(2)

However, you cannot deduct a loss or outgoing under this section to the extent that:

(b)           it is a loss or outgoing of capital, or of a capital nature; or

(c)           it is a loss or outgoing of a private or domestic nature; or

(d)           it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

(e)           a provision of this Act prevents you from deducting it.

A nexus must be shown between an outgoing and the derivation of assessable income (Ure v FCT 80 ATC 4264).

Taxation Ruling TR 2019/2 Income Tax: whether penalty interest is deductible (TR 2019/2) defines penalty interest at paragraph 3 as an amount payable by a borrower under a loan agreement consideration for the lender agreeing to an early repayment of the loan. The amount payable is commonly calculated by reference to a number of months of interest payments that would have been received but for the early repayment.

Paragraph 5 of TR 2019/2 states that penalty interest is generally deductible under section 8-1 where the borrowings are used for gaining or producing assessable income or in a business carried on for that purpose and it is incurred to rid the taxpayer of a recurring interest liability that would itself have been deductible if incurred,

Paragraphs 22 to 24 of TR 2019/2 state that a deduction is not available under section 8-1 for a loss or outgoing that is capital or of a capital nature. The critical factor in determining whether penalty interest is capital in nature is the advantage sought by the early loan repayment. This is a question of fact to be considered on a case by case basis, from a practical and business point of view. Where the advantage sought is release from the recurrent liability to pay interest which have been deductible, the penalty interest payable is revenue in character. This is despite the payment displaying capital characteristics such as being a once-and-for-all type lump sum which eliminates a threatened disadvantage and produces a benefit of a lasting character for the taxpayer.

Application to your circumstances

Section 8-1 of the 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.

You took out margin loans to finance the acquisition of ASX listed shares solely to produce assessable income by way of dividend income and capital gains. Interests were paid on the margin loans and were deductible. The Break Costs were incurred when you exited the margin loans early in order to avoid interest cost expenses. You considered that on balance, it was preferable to realise your profits and pay the Break Costs rather than continue paying interests. Therefore, the Break Costs are not capital, private or domestic in nature and are deductible under section 8-1 of the ITAA 1997.

Question 2

Are Break Costs comprising of interest foregone and administration fees deductible under section 25-30 of the TAA 1997?

Yes

Detailed reasoning

Expenditure incurred in borrowing money or in the discharge of a mortgage is generally non-deductible capital expenditure. However, section 25-30 of the ITAA 1997 allows a deduction for expenditure incurred to discharge a mortgage where the mortgage is given by the taxpayer as security for the repayment of money borrowed by the taxpayer and used by the taxpayer for the purpose of producing assessable.

Paragraph 8 of TR 2019/2 states that penalty interest incurred to discharge a mortgage is deductible under section 25-30 to the extent that the loan moneys were used for producing assessable income. Unlike section 8-1, deductibility is not affected whether the expenditure is capital or revenue in nature.

Paragraph 26 of TR 2019/2 states penalty interest i.e. payment arising from early repayment of a loan is not in the nature of interest. As a consequence, such a payment may be deductible under s25-30 of the ITAA 1997.

Application to your circumstances

Section 25-30 of the ITAA 1997 allows a deduction for expenditure incurred in borrowing money where the borrowed money is used by the taxpayer for the purpose of producing assessable income.

As the margin loans were used by you solely for the purpose of producing assessable income, all expenditure incurred in discharging the loans is deductible under section 25-30(1) of the ITAA 1997.