Private ruling: Investment related interest deduction
Published: February 2015
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018 | Year ended 30 June 2019
Date scheme commenced: 1 July 2014

Ruling: Q1: Can you claim a deduction for interest on a loan used to refinance an existing business loan, after the business has ceased? | A1: Yes.

Relevant facts and circumstances: You purchased a small business with a business loan from a financial institution. The original loan was 100% for business purposes. You sold the business and applied all of the funds to the business loan. An amount is still outstanding on the loan. You are paying principal and interest on the loan. You are looking to refinance the business loan with a loan from a financial institution, at a reduced rate of interest. The loan is linked to your home loan however you will keep the loan account separate from the everyday account and home loan account. You do not have the ability to repay the loan in a lump sum however you are applying additional funds to the loan where you can.

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

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. Taxation Ruling TR 2004/4 discusses the issue of deductions for interest incurred prior to the commencement of, or following the cessation of relevant income earning activities. Paragraph 10 of TR 2004/4 states that where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and the relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing the assessable income if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period. Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgement about the nexus between the outgoing and the income earning activities. An outgoing of interest will not fail to be deductible merely because: • the loan is not for a fixed term, • the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty, or • the original loan is refinanced, whether once or more than once. However, if the taxpayer: • keeps the loan on foot for reasons unassociated with the former income earning activities, or • makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred, the nexus between the outgoings of interest and the relevant income earning activities will be broken. Paragraph 50 of TR 2004/4 states that, in weighing the factors of a case, the following should be observed: • The less the financial resources of the taxpayer, the more likely it is that an inference could be drawn that the existence of a continuing obligation to pay interest is a burdensome legacy of the past rather than a result of the taxpayer choosing to keep the loan on foot for reasons unassociated with the former income activities. • The more liquid the resources of the taxpayer, the more likely the inference could be drawn that the loan is being kept on foot for reasons unassociated with the former income earning activities. The inference is unlikely to be drawn if it would be unreasonable in the circumstances to expect the taxpayer to apply their liquid resources against the loan; • The realisation or exchange or assets without a diversion of these resources in repayment of the principal will tend to indicate a breaking of any nexus that might previously have been maintained even after the cessation of the income earning activities. • The greater the time since the cessation of the income earning activities, the more likely it is that an inference could be drawn that the continuing obligation to pay interest is a result of the taxpayer choosing to keep the loan on foot for reasons unassociated with the former income earning activities; and • Refinancing of a loan does not of itself break the nexus between the outgoings of interest under the loan and the prior income earning activities. However, the decision to refinance may, in all the circumstances, lead to the inference being drawn that the taxpayer has made a conscious decision to extend the loan, and has done this in order to derive an ongoing commercial advantage. In Placer Pacific Management Pty Limited v. FCT (1995) 31 ATR 253; 95 ATC 4459, the full Federal Court held that an expense will not cease to be deductible simply because the assessable income was earned in a year prior to the incurring of the expense. Therefore, the interest expense will be deductible under section 8-1 of the ITAA 1997 if there is a sufficient nexus or connection between the incurring of the interest expense and the assessable income that was produced by the asset that was originally purchased with the borrowed funds. In this case, the business loan will be refinanced after the cessation of business. The new principal and interest loan will have a lower interest rate meaning it can be repaid sooner than the original business loan. It is considered that the loan is not being re-financed in order to derive an ongoing commercial advantage and is not being obtained for any reason unassociated with the prior business activity. Furthermore it is considered that the connection between the incurring of the interest expense and the earning of assessable income from the business which has now ceased will not be broken by re-financing the loan. In addition, the other factors as outlined in paragraph 50 of TR 2004/4 also indicate that the nexus between the outgoings of interest and the relevant income earning activities has not been broken. Therefore it is concluded that the interest on the refinanced business loan is deductible under section 8-1 of the ITAA 1997.