Private ruling: Deductions - rental expenses - interest expenses
Date of advice: 30 May 2016
Published: July 2016
Ruling period: Year ending 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Are you, in your capacity as individual, entitled to claim a deduction for interest expenses incurred in relation to the rental property? | A1: No.

Relevant facts and circumstances: You and another individual are beneficiaries of a trust, which is a discretionary trust. You and another individual are also trustees of the trust. The legal owner of the rental property is the trust. The mortgage for the property was taken out by you and another individual. The trust has declared all income derived from the property in its own trust tax return. The trust has only made tax losses since it was established. The interest on the loan so far has been claimed in the 2012-13, 2013-14 & 2014-15 financial year trust tax returns.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1.

Reasons for decision: Summary: The general provision that determines the deductibility of expenses is section 8-1 of the ITAA 1997. Under section 8-1 of the ITAA 1997 you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income. No deduction is available unless there is a nexus between the incurring of the outgoing and the derivation of assessable income or the prospect of the derivation of assessable income as a consequence of the particular outgoing. The Commissioners view on the deductibility of interest expenses incurred by beneficiaries of discretionary trusts is set out in Taxation Ruling IT 2385. It is the Commissioners view that deductions are not allowed to beneficiaries of trusts in relation to trust income unless it is established that the beneficiary was presently entitled to the income at the time the expenditure was incurred. A beneficiary of a discretionary trust does not become presently entitled to any income of the trust until the trustee exercises his or her discretion in favour of the beneficiary. This is so even though the trustee and the beneficiaries may be the same persons and the trustee intends to distribute income to him or herself. Until the trustee exercises his or her discretion in favour of the beneficiary, the beneficiary has no more than a mere expectation that they will derive assessable income from the trust. A mere expectation is not considered to be sufficient to establish a nexus between assessable income and expenditure incurred. IT 2385 followed the Administrative Appeals Tribunal decision in QT 85/1311 where the taxpayer was a beneficiary of a discretionary trust. The taxpayer was a director of the corporate trustee of the trust and his only source of income was a distribution from the trust. The taxpayer claimed as a deduction against the trust distribution for various expenses including bank interest. The Tribunal held that the taxpayer was not entitled to any deduction as the expenditure was not incurred in gaining or producing the taxpayer's assessable income. The taxpayer had not shown that there was a sufficient nexus between the expenditure incurred and the receipt of the income. At its highest the taxpayer had a mere expectation of receiving income from the trust as the taxpayer was not presently entitled to the income of the trust when the expenditure was incurred. In your case, the trust owns the rental property and derives assessable income from the property. However you borrowed money in your capacity as an individual to purchase the property. The trust is a discretionary trust and consequently you had a contingent rather than an absolute present entitlement to the trust distribution at the time of incurring the interest expense. That is, you are not entitled to any trust income until the trustee exercises their discretion in your favour. Therefore, it is considered that there will be an insufficient nexus between the interest expenses incurred on the loan and the trust income. Accordingly, you in your capacity as an individual will not be entitled to a deduction under section 8-1 of the ITAA 1997 for interest expenses in relation to the property.