Edited version of private advice

Authorisation Number: 1052390678987

Date of advice: 22 May 2025

Ruling

Subject: Deductions

Question 1

Can you claim the relevant portion of the interest on a loan used to payout your ex-spouse's 50% share of the partnership assets farm and equipment which you continue to use trading as a sole trader?

Answer 1

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

XX XX 20XX

Relevant facts and circumstances

You were in a partnership with your ex-spouse.

The partnership operated a farm and also an excavation business.

As part of the court order, you were required to payout the ex-spouse for her share of the farm and the plant equipment.

A formal valuation was completed to determine the value of the farm and equipment. A fair market valuation, for plant and equipment was given (in their current condition).

When the partnership ceased, the plant and equipment was transferred to you at the written down value and the farmland was transferred at cost price.

You now operate as a sole trader.

Court orders from the Federal Circuit and Family Court of Australia outlined the settlement and refinancing of the property, the farm, equipment and water rights.

A copy of the court orders was attached with the ruling application.

You acquired a loan to pay your ex-spouse $XXX,000 as part of the settlement and also to payout the existing loan that was for the acquisition of the farm.

Bank cheques form, the Bank on settlement X XX 20XX was paid as follows:

               $XXX,XXX to pay out the existing loan

               $XXX,XXX to settle ownership in the property, farm and equipment.

You have provided emails from the Bank confirming the break-up and payment at settlement at the law officers.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 51

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-5

Reasons for decision

Subsection 8-1(1) of the ITAA 1997 states that 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.

Section 25-25 of the ITAA 1997 provides that you can deduct expenditure incurred in taking out a loan for the purpose of producing assessable income.

In respect of the deductibility of interest on your borrowed funds, the law requires that the interest is incurred in the course of producing your assessable income. Whether interest has been incurred in the course of producing your assessable income generally depends on the use to which your borrowed funds have been put.

In Ure v. FC of T 81 ATC 4100; 11 ATR 484, Brennan J said:

'Section 51 requires that a deductible expenditure be incurred 'in' gaining assessable income, that is to say, it must be incidental and relevant to the gaining of that income.'

(Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 78 CLR 47 at p. 56).

'An outgoing of interest may be incidental and relevant to the gaining of assessable income where the borrowed money is laid out for the purpose of gaining that income.'

(FC of T v Munro (1926) 38 CLR 153 at pp. 170, 171, 197; Texas Co. (Australasia)

Ltd v FC of T (1940) 63 CLR 382 at p. 468). The laying out of the borrowed money for the purpose of gaining assessable income furnishes the required connection between the interest paid upon it by the taxpayer and the income derived by him from its use

[section 51 of the Income Tax Assessment Act 1936 (ITAA 1936) is equivalent to section 8-1 of the ITAA 1997]

As it was pointed out in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950 22 ATR 613:

'the reference in it [s51(1)] to 'the assessable income' is not to be read as confined to assessable income actually derived in the particular tax year. It is to be construed as an abstract phrase which refers not only to assessable income derived in that or in some other tax year but also to assessable income which the relevant outgoing ' would be expected to produce'

Where funds have been used to acquire capital assets, the interest may still be deductible if actually incurred in gaining or producing assessable income (for example if the property acquired with the funds is of an income producing nature.

Taxation Ruling TR 95/25 provides the following general principles which are relevant to the question whether interest is deductible under section 51-1 of the ITAA 1936:

a) The interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be of a capital, private, or domestic nature. The test is one of the characterisation and the essential character of an expense is a question of fact to be determined by reference to all the circumstances.

b) The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower. However, regard must be had to all the circumstances, including the character of the taxpayer's undertaking or business, the objective purpose of the borrowing, and the nature of the transactions or series of transactions of which the borrowing of funds is an element. In some cases, the taxpayer's subjective purpose, intention or motive may be relevant in deciding the deductibility of interest.

c) A tracing of the borrowed money which established that it has been applied to an income producing use may demonstrate the relevant connection between the interest and the income producing activity

The Court gave you an opportunity to buy out your ex-spouse's interest in the property including the farm and equipment. In this case, the borrowed funds to pay your ex-spouse specified the amounts in the Court Order.

The amount for the XX% share of the farm and equipment was calculated after taking into consideration all the combined assets and liabilities of the partnership.

Consequently, it is agreed the borrowed funds was used to acquire an asset of an income producing nature (ex-spouse's interest in the farm and equipment).

Accordingly, the interest on the portion of the borrowed funds attributable to the purchase of your ex-spouse's previous interest in the farm and equipment is deductible in the years the interest is incurred.