ATO ID 2012/91: Deductibility of net amounts on borrowings
Date of decision: 25 October 2012
Year of income: Year ended 30 June 2010 Year ended 30 June 2011
Business line: Public Groups and International

Issue
Can a net amount be a loss or outgoing incurred by a taxpayer within the meaning of section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) where the net amount is the excess of interest expense incurred by the taxpayer on borrowings to fund a particular asset over the income derived by the taxpayer from the asset?

Decision
No. A net amount which is the excess of interest expense incurred by the taxpayer on borrowings to fund a particular asset over the income derived by the taxpayer from the asset, cannot be the loss or outgoing incurred by the taxpayer within the meaning of section 8-1 of the ITAA 1997.

Facts
A foreign bank is incorporated and resident of a foreign country for Australian tax purposes. The foreign bank carries on business operations through a fixed place of business in Australia (Australian branch operations). The foreign bank maintains general reserve liquid assets (liquid reserve assets). The foreign bank incurs interest expense on borrowings that fund the liquid reserve assets. The foreign bank derives interest and other income from the liquid reserve assets. The interest expense incurred exceeds the income derived from the liquid reserve assets. Such excess is referred to as a 'net loss' or 'negative spread'. The bank includes the whole or part of such net amount as a 'cost' of particular operations of the bank in the accounts used by the bank for its internal management purposes.

Reasons for decision
Summary: A 'net amount' cannot be the loss or outgoing incurred under section 8-1 of the ITAA 1997 (previously subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936)) unless, if the net amount were instead a profit, such net amount would be assessable income derived for the purposes of applying the general income provision in section 6-5 of the ITAA 1997 (previously subsection 25(1) of the ITAA 1936): refer to AVCO Financial Services v. Federal Commissioner of Taxation (1982) 150 CLR 510; (1982) 13 ATR 63; 82 ATC 4246, Coles Myer Finance v. Federal Commissioner of Taxation (1993) 176 CLR 640; (1993) 25 ATR 95; 93 ATC 4214 at ATC 4224, 4230 and 4231 and Federal Commissioner of Taxation v. Energy Resource of Australia (1996) 185 CLR 66; (1996) 33 ATR 52; 96 ATC 4536. Refer also to Federal Commissioner of Taxation v. Citibank (1993) 44 FCR 434; (1993) 26 ATR 423; 93 ATC 4691 at 4701 for how a net amount may be assessable income only if 'the gross receipts used in the calculation of net profit were itself not income in ordinary concepts'. Accordingly the relevant amount incurred by the bank under section 8-1 of the ITAA 1997 is the interest expense incurred by the foreign bank on the borrowings funding the liquid reserve assets (which was subtracted by the bank in calculating the 'net loss' or 'negative spread' included as a 'cost' in its management accounts). The income derived by the foreign bank for the purpose of applying section 6-5 of the ITAA 1997 includes the income derived by the bank from the assets (that is, the amount of income from which the interest expense was subtracted by the bank in calculating the amount of the 'net loss' or 'negative spread').

Legislative references: Income Tax Assessment Act 1997 section 6-5 section 8-1
Case references: AVCO Financial Services v Federal Commissioner of Taxation (1982) 150 CLR 510 (1992) 13 ATR 63 82 ATC 4246
Related ATO interpretative decisions: ATO ID 2012/90 | ATO ID 2012/92
Subject references: Deductions & expenses Interest expenses