Edited version of private advice

Authorisation Number: 1052298234609

Date of advice: 3 September 2024

Ruling

Subject: Income tax - deductibility of bank interest

Question 1

Will the interest expense incurred on the loan be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) when the Trust sells the initial asset acquired using the borrowed funds and then reinvests the proceeds in other income producing assets?

Answer

Yes.

This ruling applies for the following periods:

Income tax year ending 30 June 2023

Income tax year ending 30 June 2024

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

1. The Trust drew down on a loan on XX month 20XX for a single loan amount of $XXXX. The Trust declaration was signed on this date.
2. The Trust is a discretionary trust.
3. The loan was for:
   • Investment property (Property A) - settled XX month 20XX
   • Investment property (Property B) - settled XX month 20XX
   • Other private investments permitted by the Trust deed.
4. The total funds to acquire the properties exceeded the initial loan amount.
5. The interest has been claimed as a deduction from XX month 20XX.
6. On XX October 20XX, Property B was sold for approximately $XXXX.
7. In month 20XX, the Trust invested in Company X which had entered into a contract to acquire management rights of a high-rise complex.
8. The sale proceeds from Property B were re-deployed and the Trust invested a total of $XXXX in the following manner:
   • $XXXX for a XX% holding in Company X
   • $XXXX as a loan to Company Y deriving a commercial rate of interest.
9. The remainder of the borrowed funds continue to be applied towards the other original income producing purposes described at paragraph 3 above.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Reasons for decision

Summary

The interest expenses incurred by the Trust remain deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) is the general deduction provision. Under subsection 8-1(1) of the ITAA 1997 any loss or outgoing is deductible to the extent that it is:

a)  red in gaining or producing assessable income; or

b)  sarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities (TR 2004/4) further focuses on tracing the application of the borrowed monies, i.e., "the use to which the borrowed funds were put".

Paragraph 6 of Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities (TR 2004/4) explains that the deductibility of interest is typically determined through the examination of the purpose of the borrowing and the use to which the borrowed funds are put (Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613, FC of T v Energy Resources of Australia Limited 96 ATC 4536; (1996) 33 ATR 52, and Steele v. FC of T 99 ATC 4242; (1999) 41 ATR 139 (Steele)).

Paragraph 7 of TR 2004/4 states that ordinarily '...the purpose of the borrowing will be ascertained from the use to which the borrowed funds were put...' (Hill J in Kidston Goldmines Limited v FC of T 91 ATC 4538 at 4545; (1991) 22 ATR 168 at 176). However, as his Honour later observed in FC of T v JD Roberts; FC of T v Smith 92 ATC 4380 at 4388; (1992) 23 ATR 494 at 504, '...a rigid tracing of funds will not always be necessary or appropriate...'

Where borrowed funds are applied to a purpose that involves the gaining or producing of assessable income then absent other considerations which are not relevant here, the interest is deductible under section 8-1 of the ITAA 1997.

Application to your circumstances

In this case, the proceeds from the sale of Property B have been applied to the acquisition of further income producing assets meaning the purpose to which the borrowed funds (recouped from the sale of Property B) have been put is such that the testing in section 8-1 of the ITAA 1997 remains satisfied and the interest is deductible. In addition, the balance of the borrowed funds (being the borrowed funds not originally applied to the purchase of Property B) continue to be applied to the other original income producing purposes.

This means the interest incurred by the Trust on the loan contemplated by this Ruling continues to be deductible in full under section 8-1 of the ITAA 1997.