Private ruling: Interest deduction on loan to pay income tax
Date of advice: 19 October 2017
Published: March 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Can you claim a portion of the interest incurred on a loan taken out to pay Income tax and GST liabilities, which relates to your business income, under section 8-1 of the Income Tax Assessment Act 1997 ? | A1: Yes

Relevant facts and circumstances: You are an Australian resident for tax purposes. You hold an ABN and are registered for GST. You are a medical specialist with your own private practice business which generates your business income. You also receive income from employment wages. You also receive rental income from an investment property. You intend to use a separate sole purpose loan facility through your bank to fund repayments of your income tax and GST liabilities.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 25-2 | Income Tax Assessment Act 1997 section 27-15

Reasons for decision: Summary: A deduction will be allowed under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for interest incurred on funds borrowed, where the funds were used to pay income tax and GST arising from your business activities. However no deduction is allowable for the portion of the interest that relates to payment of tax liabilities from your wages and investment income. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the ITAA 1997 allows a deduction for expenses necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowable if the expense is of a private, domestic or capital nature. In general the character of interest is determined with reference to the use to which the borrowed funds are put ( Commissioner of Taxation v. Roberts; Commissioner of Taxation v. Smith (1992) 37 FCR 246; 92 ATC 4380; (1992) 23 ATR 494). Funds borrowed to pay income tax Paragraph 25-5(2)(c) of the ITAA 1997 provides that expenditure on money borrowed to pay tax, including payments of interest, cannot be deducted as a tax related expense under subsection 25-5(1) of the ITAA 1997. However Taxation Ruling IT 2582 states that where a taxpayer carries on a business and, in connection with that business, borrows money to pay income tax, then it is considered that the interest incurred is a normal incident of conducting a business and is therefore deductible. While the taxation ruling has a reference to companies carrying on a business, the same approach is applicable to an individual carrying on a business as a sole trader. You have advised that your taxable income is generated from salary and wages, investment property income and your personal business activities. As the Income Tax amount you are liable to pay is not fully resultant from your business undertakings you are expected to apportion the amount of interest you can claim from your loan based on a reasonable calculation. While the Pay As You Go Withholding (PAYGW) amounts withheld by your employer from your wages will be applied to your income tax liabilities, the payments are applied to the total amount of income tax owing for the year of assessment as a whole liability and not on a component of income type basis. Funds borrowed to pay GST GST is not an allowable deduction by virtue of section 27-15 of the ITAA 1997. However, this section does not deny a deduction for interest incurred on funds borrowed to pay GST. As stated above, interest takes it character from the use to which the borrowed funds are put. The obligation to pay GST arises from the provision of goods and services by a taxpayer in the course of carrying on its business. As such, the GST expense is incurred in carrying on the business. Therefore, the interest on funds borrowed to pay this expense will also be incurred in carrying on the business and would generally be an allowable deduction under section 8-1 of the ITAA 1997. As the GST liability is resultant only from your business activities no apportionment of the amounts used to pay your GST liability would be required.

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