Private ruling: Deductibility of interest accrued on bank debt
Published: September 2013
Ruling period: 01 July 2012 to 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Will the interest incurred on the bank debt taken out by Company B to repay a loan owed by Company B to the Trust be deductable to Company B pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will section 109J of the Income Tax Assessment Act 1936 (ITAA 1936) apply to prevent the payments by Company C to the spouse, pursuant to a settlement order of the Family Court of Australia under the Family Law Act 1975 (FLA 1975), from attracting the operation of subsection 109C(1) of the ITAA 1936? | A2: This request is invalid. | Q3: Will the payments be treated as dividends in the hands of the spouse as defined in section 6(1) of the ITAA 1936? | A3: This request is invalid. | Q4: Will the payments be assessable income of the spouse under either section 6-5 or section 6-10 of the ITAA 1997 or subsection 44(1) of the ITAA 1936? | A4: This request is invalid. | Q5: Will the payments be treated as a fringe benefit for the purposes of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)? | A5: No | Q6: Will Part IVA of the ITAA 1936 be engaged in relation to the entire transaction? | A6: No

Relevant facts and circumstances: The shareholder and spouse, separated in the 2010 income year. The shareholder and his associated entities own 100% of the issued shares in Company B and Company C. The shareholder is the sole director of both companies. The term 'associated entities' does not include the former spouse as a shareholder, director or unit holder of any of those entities. Company B operates a number of businesses and is part of a corporate group that is controlled by the shareholder. Company C does not carry on any business activities. The former spouse: · is not currently a shareholder or a director of Company C; and · will not be an shareholder or a director of Company C at the time when the payments are made to them. · has never been nor is currently an employee of Company C; and · will not be an employee of Company C at the time when the payments are made to them. The shareholder: · has never been nor is currently an employee of Company C; and · will not be an employee of Company C at the time when the payments are made to their former spouse. Discussions have commenced between the parties with respect to a property settlement. The parties including, Company C as the company required to make payments to the former spouse, intend to apply to the Family Court of Australia (FCA) for a court property settlement order under section 79 of Part VIII of the FLA 1975. It is intended that the property settlement will involve payments being made to the former spouse. Under the binding settlement order Company C will make payments by drawing upon unpaid present entitlements to trust income from the Trust. The Trust was established by the Deed of Trust, and amended from time to time. The Trust is a discretionary family trust. The Trustee of the Trust is now Company D. The shareholder is the sole director and shareholder of Company D. Pursuant to the Trust Deed the shareholder is a secondary beneficiary of the Trust. The Trust will fund the payment of the unpaid present entitlements by calling for partial repayment of amounts loaned by it to Company B in previous years. Company B will in turn fund the partial repayment of the amounts loaned to it by the Trust by either utilising its own cash flows or borrowing an appropriate amount from its bank at commercial rates of interest. The shareholder does not have the financial capacity or loan repayment cash flow necessary to make the settlement payments. The corporate group is the only source with the financial capacity to make the settlement payments. Within the corporate group, it is not desirable for Company B to be the paying company because it diminishes its ability to make future dividend payments to its shareholders and would result in an adverse reduction in the net assets of the company. A reduction in the net assets of Company B would jeopardise their ability to receive certain types of funding and therefore payments from Company B under a settlement order would not be desirable.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1936 Section 109J | Income Tax Assessment Act 1936 Section 109C(1) | Income Tax Assessment Act 1936 Section 6(1) | Income Tax Assessment Act 1997 subsection 6-5(1) | Income Tax Assessment Act 1997 subsection 6-5(2) | Income Tax Assessment Act 1997 subsection 6-10(2) | Income Tax Assessment Act 1997 section 10-5 | Income Tax Assessment Act 1936 Subsection 44(1) | Fringe Benefits Tax Assessment Act 1986 Subsection 136(1) | Income Tax Assessment Act 1936 Section 177F | Income Tax Assessment Act 1936 Section 177F(1) | Income Tax Assessment Act 1936 Sections 177D, 177D(a), 177D(b) | Income Tax Assessment Act 1936 Sections 177A(1),177A(5) 177C(1) | Taxation Administration Act 1953 Division 359

Reasons for decision: Summary: The interest which would be incurred on bank debt taken out by Company B to repay a loan owed by Company B to the Trust would be deductable to Company B pursuant to section 8-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the ITAA 1997 allows a deduction for loss or outgoing to the extent that it is: a. incurred in gaining or producing your assessable income and the loss or outgoing is not capital, or of a capital, private or domestic nature; or b. it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income and the loss or outgoing is not capital, or of a capital, private or domestic nature. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith deals with the deductibility of interest under section 8-1 of the ITAA 1997 following FC of T v. Roberts; FC of T v. Smith (Roberts and Smith). It reaffirms the refinancing principle in Roberts and Smith in relation to common law partnerships. The refinancing principle in Roberts and Smith is that the interest on a borrowing by a common law partnership to fund repayment of moneys originally advanced by a partner and used as partnership capital will be deductible to the extent the partnership capital was employed in a business of the partnership which was carried on for the purposes of producing or gaining assessable income. | Detailed Reasoning - Application of TR 95/25 to deductibility of interest: The test for whether the interest on bank debt taken out by Company B to repay a loan owed by Company B to the Trust would be deductable pursuant to section 8-1 of the ITAA 1997 is set out in paragraph 15 of TR 95/25. Pursuant to paragraph 15 of TR 95/25 the test is whether the original loan which is replaced by the bank debt (i.e. the repaid loan) was employed as working capital in the business carried on by the borrowing company for the purposes of deriving its assessable income. In this case, the original loaned funds from the Trust to Company B were utilised by Company B (being the borrowing company) for working capital purposes in the businesses carried on by Company B. Therefore, the test would be satisfied because the repaid loan was employed as working capital in the business carried on by Company B for the purposes of deriving its assessable income. Accordingly, the interest on bank debt taken out by Company B would be deductible by Company B under section 8-1 of the ITAA 1997. | Summary: This request is invalid, as you are not the entity, or its agent or legal representative to whom this ruling question applies. | Detailed Reasoning - Detailed reasoning: In accordance with Division 359 of the Taxation Administration Act 1953 (TAA), for a private ruling application to be valid, the person applying for the ruling (the applicant) must be the entity, as defined in section 960-100 of the ITAA 1997, the ruling will apply to, or its agent or legal representative. This question seeks advice for a taxpayer that you are not authorised to act on behalf of, therefore your application is invalid in relation to this question. | Summary: This request is invalid, as you are not the entity, or its agent or legal representative to whom this ruling question applies. | Detailed Reasoning - Detailed reasoning: In accordance with Division 359 of the TAA, for a private ruling application to be valid, the person applying for the ruling (the applicant) must be the entity, as defined in section 960-100 of the ITAA 1997, the ruling will apply to, or its agent or legal representative. This question seeks advice for a taxpayer that you are not authorised to act on behalf of, therefore your application is invalid in relation to this question. | Summary: This request is invalid, as you are not the entity, or its agent or legal representative to whom this ruling question applies. | Detailed Reasoning - Detailed reasoning: In accordance with Division 359 of the TAA, for a private ruling application to be valid, the person applying for the ruling (the applicant) must be the entity, as defined in section 960-100 of the ITAA 1997, the ruling will apply to, or its agent or legal representative. This question seeks advice for a taxpayer that you are not authorised to act on behalf of, therefore your application is invalid in relation to this question. | Summary: The payments will not give rise to a fringe benefit for the purposes of subsection 136(1) of the FBTAA. | Detailed Reasoning - Detailed reasoning: A taxable fringe benefit will arise where the following circumstances are satisfied: · a benefit is provided to an employee, an associate of an employee, or some other person at the direction of an employee or an associate of an employee · the benefit is provided by the employee's employer, by an associate of the employer, or by a third party under an arrangement with the employer or with an associate of the employer · the benefit is provided in respect of the employment of the employee. An 'employee' is defined under subsection 136(1) of the FBTAA as being a current employee, a future employee or a former employee. 'Associate' of an employee is defined in subsection 318(1) of the ITAA 1936 and includes a spouse. However, subsection 318(7) of the ITAA 1936 excludes from being a spouse a person who is legally married to the employee but is living separately and apart from them on a permanent basis. In this case, the shareholder and their former spouse have separated and are now divorced. 'Benefit' is defined broadly under subsection 136(1) of the FBTAA and includes any right, privilege, service or facility that is, or is to be, provided under arrangement for or in relation to the performance of work. In this case, the payments will not be made to an employee of Company C because the shareholder has never been nor is currently an employee of Company C. Nor will they be an employee of Company C at the time when the payments are made to the former spouse. The payments will not be made to an associate of an employee because the shareholder has never been nor is currently an employee of Company C. Also, the shareholder and the former spouse are now divorced. Furthermore, the payments to the former spouse by Company C will be as a consequence of a binding settlement order and not in relation to an employment relationship. Accordingly, the payments will not give rise to a taxable fringe benefit within subsection 136(1) of the FBTAA. | Summary: The provisions of Part IVA of the ITAA 1936 will not apply to the arrangement because there is no tax benefit. | Detailed Reasoning - Detailed reasoning: Part IVA of the ITAA 1936 is a general anti-avoidance provision that gives the Commissioner the discretion to cancel all or part of a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained by a taxpayer in connection with a scheme to which Part IVA applies. Before the Commissioner can exercise the discretion in subsection 177F(1) of the ITAA 1936, the requirements of Part IVA must be satisfied. These requirements are contained in section 177D of the ITAA 1936, namely: · A taxpayer (referred to as the 'relevant taxpayer') has obtained, or would obtain but for section 177F, obtain a 'tax benefit' in connection with the scheme (paragraph 177D(a)); and · Having regard to the eight factors in paragraph 177D(b), it would be concluded that the scheme was entered into for the sole or dominant purpose of enabling the relevant taxpayer to receive the tax benefit. | Detailed Reasoning - The scheme: For Part IVA of the ITAA 1936 to apply, the identified scheme must fall within the wide definition of 'scheme' in subsection 177A(1) of the ITAA 1936. In Federal Commissioner of Taxation v Hart [2004] HCA 26 at [43], Gummow and Hayne JJ held that the definition of 'scheme' (Hart): '….is very broad. It encompasses not only a series of steps which together can be said to constitute a "scheme" or a "plan" but also (by its reference to "action" in the singular) the taking of but one step.' With respect to this private ruling, the Commissioner considers the relevant scheme is the proposed arrangement whereby payments will be made to the former spouse. These payments will be paid by Company C to the former spouse under a binding settlement order. Company C will be joined as a party to the settlement order as the company required to make the payments to the former spouse. It is intended that Company C will make the payments to the former spouse by drawing upon unpaid present entitlements to trust income from the Trust. The Trust will fund the payment of the unpaid present entitlements by calling for partial repayment of amounts loaned by it to Company B. | Detailed Reasoning - A tax benefit: Part IVA of the ITAA 1936 cannot apply unless a taxpayer has obtained (or would obtain but for section 177F of the ITAA 1936) a tax benefit in connection with a scheme. Subsection 177C(1) of the ITAA 1936 defines four kinds of tax benefit, relating broadly to: (a) an amount not being included in the assessable income of the taxpayer of a year of income; (b) a deduction being allowable to the taxpayer in relation to a year of income; (c) a capital loss being incurred by the taxpayer during a year of income; (d) a foreign tax credit being allowable to the taxpayer. The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an 'alternative hypothesis' or 'alternative postulate' and is what would have happened if that particular scheme had not been entered into or carried out: Hart . The Commissioner calls these alternative hypotheses 'counterfactuals': Law Administration Practice Statement PS LA 2005/24: Application of General Anti-Avoidance Rules (PS LA 2005/24) You have asserted that there is no counterfactual and that the proposed transaction is the only identified means of meeting the property settlement without causing unacceptable balance sheet consequences for Company B. Based on the facts of this private ruling, the Commissioner agrees with this conclusion. Therefore, the Commissioner considers that there is no 'tax benefit' as defined in subsection 177C(1) of the ITAA 1936 and, accordingly, the requirement in paragraph 177D(a) of the ITAA 1936 is not satisfied. It is therefore not necessary to consider the eight factors in paragraph 177D(b) of the ITAA 1936 to determine whether the scheme was entered into for the sole or dominant purpose of enabling the relevant taxpayer to receive the tax benefit, because there is no 'tax benefit' as required under paragraph 177D(a). Accordingly, the provisions of Part IVA of the ITAA 1936 do not apply to the arrangement because there is no tax benefit.