Private ruling: Interest expenses
Published: June 2012
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you entitled to a deduction for interest expenses relating to previous financial years in the year ended 30 June 2011? | A1: No. | Q2: Is the interest expense deductible in the financial years to which it is referrable? | A2: Yes. | Q3: Do the non-commercial loss provisions of Division 35 of the Income Tax Assessment Act 1997 (ITAA 1997) require you to defer the interest expense which relates to loans to a related company to a later income year? | A3: No.

Relevant facts and circumstances: You borrowed funds from overseas lenders who charged you interest. You used the borrowed funds to: · purchase shares in two companies, and · provide interest-bearing loans to Company A, a related company, to finance working capital requirements on an ad hoc basis. The companies you purchased shares in are listed on the Australian Stock Exchange. The shares were purchased for long-term investment and with the expectation that the shares would generate dividends in the future. You received dividends during the financial year ended 30 June 2011. Company A was involved in a project which has now been completed. The project was delayed due to the global financial crisis. The loan balances and accrued interest are repayable upon finalisation of the project. The interest rate on the loans to Company A is the same as the interest rate charged to you by the overseas lenders. You have not provided loans to other entities. Due to the project delays, the overseas lenders agreed that the interest and principal repayments in relation to the loans would be due and payable as follows: · interest accrued as at 30 June 2010 to be paid during the 2010-11 financial year · interest accrued between 1 July 2010 and 31 December 2011 to be paid upon maturity, and · principal to be repaid on maturity. During the 2010-11 financial year you paid the interest which had accrued to the overseas lenders. You remitted the withholding tax relating to these payments to the Tax Office. You account for your income and expenses on a cash basis.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 26-25 | Income Tax Assessment Act 1997 Section 35-5

Reasons for decision: Summary: The interest incurred on the loans from the overseas lenders is deductible in the financial year in which it accrued. This is because the Commissioner considers you were committed to making the interest payments as they accrued. The fact that the lenders agreed to a revised payment schedule does not change this commitment. As you are not carrying on a business the non-commercial loss provisions of the tax legislation do not prevent you from claiming a deduction for the interest expense in the relevant financial years. | Detailed Reasoning - Interest expense: Section 8-1 of the ITAA 1997 allows a deduction for losses or outgoings incurred in earning assessable income. No deduction is allowable where the loss or outgoing is of a capital, private or domestic nature. Interest on loans is generally deductible where the borrowed funds have been used to earn assessable income. Where the funds were borrowed from overseas lenders, the taxpayer must withhold tax from the interest payment and remit that amount to the Tax Office. If the taxpayer fails to do so, no deduction is allowable. In your case you have borrowed funds and used them to purchase shares in listed companies. Some funds were lent to Company A to assist in a project. You have received dividend income from the companies and will receive interest on the loans to Company A when the project has been finalised. As the borrowed funds have been used for income producing purposes, and you have withheld tax from the interest paid to the overseas lenders, you are entitled to deductions for the interest expenses incurred. | Detailed Reasoning - Timing of interest expense deductions: Taxation Ruling TR 97/7 explains the meaning of 'incurred' for the purposes of section 8-1 of the ITAA 1997. It sets out general rules, settled by case law, that assist in most cases in determining whether and when a loss or outgoing has been incurred. The key principles are: · incurred does not equate to having been paid · the taxpayer must be definitely committed to the outgoing in the year of income. That is, it must be a presently existing liability to pay a pecuniary sum · it is not a presently existing liability if it is contingent, and · incurred does not include amounts which are merely impending, threatened or expected. Whether there is a presently existing pecuniary liability in a year of income requires consideration of the facts of each case, having regard to the source of the liability. For the purposes of section 8-1 of the ITAA 1997 it is sometimes not enough that a loss or outgoing has been incurred. The outgoing must also be properly referable to the year of income in which the deduction is sought. Your accounting system may be indicative, but not determinative of the financial year to which an outgoing is properly referable. In your case the source of your liability to pay interest to the overseas lenders arose from your entering loan agreements with the overseas lenders to borrow funds. Each loan agreement specified the interest rate payable on the unpaid loan principal. The interest liability exists for each day in an income period that each loan principal remains unpaid. This will generally be from the day the funds were advanced to you until the date of repayment. The Commissioner considers that a presently existing liability to pay the interest on a loan comes into existence each day the loan principal remains unpaid. As the interest is subject to a loan agreement, it is not considered to be contingent, merely impending, threatened or expected. Thus, while you did not pay the interest expense to the overseas lenders until the 2010-11 financial year, it is considered that the interest was incurred in each financial year to which it is referable. The Commissioner considers that you were definitely committed to paying the interest which had accrued during a particular financial year as at the 30 June that financial year. That is, for example, on 30 June 2007 you were committed to the interest expense that accrued during the period 1 July 2006 to 30 June 2007. You are not entitled to claim a deduction for the accrued interest expense in the year ended 30 June 2011 as this amount was incurred prior to 1 July 2010. | Detailed Reasoning - Non-commercial losses: Division 35 of the ITAA 1997 applies to losses from certain business activities for the year ended 30 June 2001 and subsequent years. The provisions only apply to individuals who conduct a business activity as either a sole trader or a partner in a partnership and made a loss from that business activity. You are not considered to be carrying on a business of money lending as: · you have made loans solely to Company A - a related party · the loans have been made on an ad hoc basis as required · the interest charged on the loans to Company A is equivalent to the interest charged to you by overseas lenders · the overseas lenders are the source of the funds you on-lent to Company A. As you are not carrying on a business of money lending, the non-commercial loss provisions do not prevent you from claiming deductions for the interest expense in the relevant financial years.

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