Edited version of private advice

Authorisation Number: 1051925775067

Date of advice: 8 February 2022

Ruling

Subject: Deductions

Question

Will the interest on a refinanced bank loan be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), where the refinanced amount is used for the GHI Family trust?

Answer

Yes.

This ruling applies for the following periods:

year ending 30 June 20XX

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

DEF Pty Ltd (DEF) as trustee for the GHI Family Trust (the trust) is a discretionary trust that was created in 19XX.

D (D) is the sole director of DEF and sole beneficiary of the trust

Originally the trust undertook business activities. The trust no longer undertakes these activities.

The trust currently holds x properties, Property B (B property) is the only property that is leased.

As of XX Jxxx 20XX, your balance sheet shows you had 2 active mortgages with XYZ (XYZ):

•         XXXXX (XYZ 001) with a balance of $XXX,XXX DR

•         XXXXX (XYZ 002) with a balance of $XXX,XXX DR

Since XX Jxxx 20XX, XYZ 002 loan has been repaid and closed.

Between 20XX and 20XX, the XYZ 001 loan balance was reduced from $ XXX,XXX.

On XX Mxxx 20XX, D refinanced the XYZ 001 loan, by taking out a loan for $XXX,XXX through the UVW (UVW). D took out the loan to refinance the XYZ 001 loan in their own name as the trust was not in a financial position to satisfy the UVW's lending policy, as the trust was only receiving income from B property.

On XX Mxxx 20XX, UVW property loan number XXXXX (UVW 003) was drawn down for $XXX,XXX and XYZ 001 loan was reduced to NIL.

A letter from UVW confirms that UVW 003 loan was provided to refinance the loan in the name of DEF ATF the GHI Family Trust from XYZ (XYZ 001 loan) for B property.

An offset account was linked to the UVW 003 loan. The offset account is a transaction account that D uses as a personal account. The offset account is separate from the UVW 003 loan and any credit funds in the offset account reduce the amount of interest charged to the UVW 003 loan.

As the trust is not in a position to fully support the loan, so D supplements the repayments required to maintain UVW 003 loan.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Detailed reasoning

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 capital, private or domestic nature.

Several significant court decisions have determined that for an expense to be an allowable deduction:

•         there must be a sufficient nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income,

•         it must have the essential character of an outgoing incurred in gaining assessable income or of an income producing expense, and

•         it is necessary to determine the connection between outgoing and the operational activities by which the taxpayer most directly gains or produces assessable income.

Tax Ruling 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; 92 ATC 4380; (1992) 23 ATR 494 provides the Commissioner's view regarding the deductibility of interest and outlines 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, it is necessary to examine 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 CR 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.

Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. Where you refinance from an existing loan, this transaction is considered to be a new borrowing and the nature of this borrowing will be determined by its use (Taxation Ruling TR 2000/2: Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities).

The Commissioner accepts that interest accrued on the debt incurred in refinancing a loan for an income producing portion will be deductible. At paragraph 22 of TR 2000/2 the Commissioner states that the deductibility of interest on a further borrowing of money under a refinancing agreement depends on the use to which the borrowed funds are put. If this is non-income producing purpose, then the interest on the redraw amount is not deductible.

Application to your circumstances

In your case, the UVW 003 loan was taken out by D to refinance the XYZ 001 loan. The UVW 003 loan was taken out in D's name as the trust's income was limited to the rental payments from the B property and hence could not meet the bank's lending policy. UVW has confirmed that the loan taken out by D was to refinance the XYZ 001 loan for the B Property. As the B property is an income generating asset and it is considered the UVW 003 loan is connected to that property, the interest incurred on the UVW 003 loan will be deductible.