Taxation Ruling

IT 2604

Income tax: assessability of interest to investors in the pyramid, geelong and countrywide building societies

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FOI status:

May be releasedFOI number: I 1012244

PREAMBLE

The purpose of this Ruling is to clarify certain issues relating to the assessability of interest income for investors in the Pyramid, Geelong and Countrywide Building Societies in the light of recent developments.

2. In media release 90/27 of 3 July 1990, the Tax Office advised that investors in the Pyramid, Geelong and Countrywide Building Societies who had not actually received interest credited to their accounts in the year ended 30 June 1990 did not have to include the amounts in their tax returns for that year. The media release went on to explain that the proper course of action was for investors to wait until the administrators of the building societies had told them what interest they would actually receive. Investors should then include the amount received in the return for that later financial year.

3. Since the media release the Tax Office has been asked a number of questions about whether in particular cases taxpayers need to include any amounts in their tax returns. As these appear fairly typical the cases submitted and the answers given are set out below for the information of taxpayers and professional advisers who are preparing income tax returns for the year ended 30 June 1990.

RULING

Scenario 1:

A taxpayer has $20,000 deposited for 10 months. Interest is credited monthly to the account, but only one withdrawal of $5,000 is made. Will any of the withdrawal be treated as interest?

Response:

Where only one withdrawal of $5000 has been made in the year ended 30 June 1990 we would treat the $5000 as being a withdrawal of principal in accordance with the common law approach of assuming that, in the absence of evidence to the contrary, the oldest debt is paid first by the borrower. (But see response on scenario 4.)

With fixed term deposits regard would have to be had to the relevant conditions attaching to the investment. For example, interest may in some cases be payable on maturity. Also,there may be restrictions on the withdrawal of principal which would give rise to an inference that interest is being withdrawn. However, in the example given it is appreciated that the rate of interest would not be $5000 on a deposit of $20,000.

Scenario 2:

A taxpayer has $20,000 deposited for 12 months. Interest is credited in December 1989, a withdrawal of $10,000 is made in April. Will any of the withdrawal be treated as interest?

Response:

It is assumed that the deposit was made on 1 July 1989. In the absence of evidence to the effect that the $10,000 withdrawn in April included any interest, the transaction would be regarded as involving a withdrawal of $10,000 principal. Naturally, if the interest credited to the depositor is in fact paid out, e.g., by cheque which the depositor was able to cash or reinvest, then the depositor will be taken to have derived the interest.

Also, if the investment was a fixed term deposit regard would have to be had to the terms attaching. The amounts withdrawn in some cases, e.g., if it were say $1000 or so, could give rise to a clear inference that the withdrawal was of the interest paid if the conditions prevented the withdrawal of principal.

Scenario 3:

We assume if the taxpayer has a cheque account to which interest is credited but he operates regularly on the account, then the interest will be taxable. Please confirm.

Response:

In this situation there is still a question whether the crediting of interest to the cheque account was simply a book entry evidencing a debt or whether the money amount of the interest was really available and was drawn on so as to be derived as income.

In normal circumstances the crediting would be enough to support a finding that the interest had been derived. A special rule applies when there is a unilateral default by a borrower and one must enquire whether the interest was really available.

The nature of current accounts is that they are often without any funds or overdrawn. Where this is the case at any time after the interest is credited the interest will be taken to have been derived.

Similarly, where the balance in the account drops below the amount of interest credited, there is evidence of at least some of the interest having been received.

Where the interest is still locked up in the cheque account it will not be taken to have been derived until such time as the administrator /liquidator makes a distribution in respect of interest payable.

The basic approach would be to apply a first in first out approach to all deposits/credits including interest where there is no indication as to whether the depositor is withdrawing principal or interest.

In a situation where a person had his or her salary credited to a cheque account (or a savings account) and within the period up to the next pay withdrawals were made which totalled the amount of the salary, or something slightly less, then the Tax Office would conclude that the depositor was withdrawing his or her pay and not interest.

Scenario 4:

Depending on the advice from the liquidator, are we entitled to assume that any early repayments are of a capital nature?

Response:

It would be normal practice for the administrator or liquidator to specify how much principal and interest is included in any distribution amounts. The Tax Office will treat the components of the distribution in accordance with the administrator/liquidator's advice.

However, if at the end of day a depositor gets back more than the amount of his or her principal, taking into account any withdrawals and distributions by the administrator/liquidator, the excess would be treated as assessable income.

COMMISSIONER OF TAXATION
26 July 1990

References

ATO references:
NO 90/5179-1

Date of effect:
Immediate

Subject References:
INTEREST INCOME
ASSESSABILITY WHERE FINANCIAL INSTITUTION MAY BE UNABLE TO PAY

Legislative References:
25(1)