Private ruling: Is interest paid considered assessable income
Published: June 2012
Ruling period: The year ending 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Will an amount of interest paid to Companies B, C and D, by the Commissioner of Taxation under the T(IOEP) A, be considered as assessable income of Company A pursuant to subsection 6-10(1) of the ITAA 1997 and section 15-35 of the ITAA 1997? | A1: Yes | Q2: Will Company A be entitled to claim deductions under section 8-1 of the ITAA 1997 in respect to the interest, or amounts in the nature of interest, incurred by Company A? | A2: Yes

Relevant facts and circumstances: Company A is the head company of a tax consolidated group for the purposes of Part 3-90 of the ITAA 1997. Company A, as head company of the tax consolidated group, has not made an election pursuant to item 103(2) or 104(2) in Schedule 1 of Part 3 of the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (TOFA Act) to have the TOFA rules apply from 1 July 2009 or to apply to its financial arrangements that were on foot as at 1 July 2010. Companies B, C and D, were once part of Company E's group. Company F acquired Companies B, C and D in 20XX. As part of the acquisition Companies B, C, D, F (the Group) and E entered into a certain obligations (Deed). The Deed provides that if any assessments are received by the Group from the Commissioner regarding the Tax Dispute (refer below) the relevant entity will notify Company E immediately and Company E will pay the Commissioner directly on their behalf. The Deed also deals with circumstances where a member of the Group receives any amount from the Commissioner in relation to the Tax Dispute and provides that the member of the Group must immediately pay that amount to Company E without deduction. In 2011 Company A acquired the Group by acquiring the parent company of Company F. As a result of the acquisition, Companies B, C, D and F and the parent of Company F became subsidiary members of Company A's tax consolidated group. None of these entities had made an election pursuant to item 103(2) or item 104(2) in Schedule 1 of Part 3 of the TOFA Act to have the TOFA rules apply from 1 July 2009 or apply to their financial arrangements that were on foot as at 1 July 2010. Tax Dispute In 20XX, members of the Group received assessment notices from the Commissioner. The assessments included the total amounts of primary tax, penalties and interest. In 20XX Company E sent a letter to Company F to reaffirm the obligations in the Deed. Company E requested that Company F sign a copy of the letter to acknowledge its agreement to the above arrangements. ln accordance with the above arrangements, in 20XX, Company E made payments to the Commissioner, on behalf of each of Companies B, C and D representing part payments of the assessments under arrangements agreed with the Commissioner. The amounts were credited to the running balance accounts of Companies B, C and D. The resolution of the Tax Dispute resulted in the refund of the part payments of the assessments and also resulted in amounts of interest payable by the Commissioner to Companies B, C and D in respect of the amounts paid by Company E to the Commissioner on their behalf (refer to subsection 9(1) of the T(IOEP)A). The amounts of interest are referred to for the purposes of this Application as the "lnterest Amounts". Pursuant to the Deed and the arrangements set out in the letter, Companies B, C D and F were required to pay any amount received from the Commissioner in relation to the Tax Dispute to Company E. The Commissioner refunded directly to Companies B and C the payments in respect of the assessments. The obligations of companies B and C to repay Company E were satisfied when Companies B and C paid an amount to Company E. Company D's obligation to repay Company E was satisfied when Company E banked the cheque in relation to the refund for that amount that had been paid by the Commissioner. The lnterest Amounts paid by the Commissioner to Companies B and C were paid directly to Companies B and C. The Interest Amounts were paid by Companies B and C to Company E in July and August 2011. The Commissioner paid to Company D an lnterest Amount in July 2011. The cheque was made payable to Company D but was sent to a Company E's address and banked by Company E. As such, the obligation of Company D to pay the amount to Company E has been satisfied. It is the amounts referable to the lnterest Amounts incurred by Company A to satisfy the obligations of Companies B, C and D to pay those amounts to Company E that are the subject of this Ruling.

Relevant legislative provisions: Income Tax Assessment Act 1997 Part 3-90 | Income Tax Assessment Act 1997 Section 6-10 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 10-5 | Income Tax Assessment Act 1997 Section 15-35 | Income Tax Assessment Act 1997 Section 701-1 | Taxation (Interest on Overpayments and Early Payments) Act 1983 | Taxation (Interest on Overpayments and Early Payments) Act 1983 Section 3 | Taxation (Interest on Overpayments and Early Payments) Act 1983 Section 9 | Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 Sub-item 103(2) of Schedule 1 | Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 Sub-item 104(2) of Schedule 1

Reasons for decision: Detailed Reasoning - Assessable income: Section 6-10 of the ITAA 1997 provides: (1) Your assessable income also includes some amounts that are not * ordinary income. (2) Amounts that are not * ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income. Section 10-5 of the ITAA 1997 follows to provide a table of provisions that include assessable income amounts that are not ordinary income. Relevantly, the table includes a reference to section 15-35 relating to interest on overpaid tax. Section 15-35 of the ITAA provides: Your assessable income includes interest payable to you under the Taxation (Interest on Overpayments and Early Payments) Act 1983 . The interest becomes assessable when it is paid to you or applied to discharge a liability you have to the Commonwealth. | Detailed Reasoning - Interest on overpayments: Entitlement to interest on certain overpayments of tax debts is set out under the T(IOEP)A. Section 9 of the T(IOEP)A provides that where, as a result of a decision to which this Act applies, the whole or part of the amount paid is deemed overpaid by the person and is refunded to the person, interest is payable by the Commissioner on amounts of tax that are overpaid. According to paragraph 3(1)(c) of the T(IOEP)A, the definition of a "decision to which this Act applies" includes a decision of the court in relation to an objection, or a decision of the Tribunal in relation to an objection. or According to paragraph 3(1)(ca) of the T(IOEP)A, the definition of a "decision to which this Act applies" includes a decision of the Commissioner to amend an assessment made in relation to a taxpayer reducing the liability of the taxpayer to tax. Relevantly, subsection 9(4) of the T(IOEP)A provides that, where the Commissioner applies an amount that has been paid by a person, against the liability of another person to pay an amount of relevant tax, the other person shall, for the purposes of the T(IOEP)A, be deemed to have paid to the Commissioner the amount of relevant tax. Accordingly, as Company E made the payments in regards to the assessments to the Commissioner on behalf of Companies B, C and D, and the Commissioner applied the payments against the liabilities of Companies B, C and D, those entities will be deemed for the purposes of the T(IOEP)A to have paid to the Commissioner those amounts. As such, interest is payable on these overpaid amounts to Companies B, C and D under section 9 of the T(IOEP)A. To be assessable under subsection 6-10(1) of the ITAA 1997, the interest payable under T(IOEP)A needs to be paid to Companies B, C and D. According to the facts, Companies B and C were paid directly from the Commissioner. In regards to Company D, the Commissioner drew a cheque to Company D, however the cheque was subsequently sent to and banked by Company E. Since the cheque was issued in the name of Company D, it is considered that the interest payable was paid to Company D. Although the Interest Amount was received by Company E, it was payable to Company D under the T(IOEP)A. Therefore it is considered that the Interest Amounts were held on trust by Company E and will be assessable to Company D as a beneficiary. | Detailed Reasoning - Single-entity rule: Under section 701-1 of the ITAA 1997, a subsidiary member of a consolidated group for any period is taken, for the purposes of calculating income tax liability, to be part of the head company of the group, rather than a separate entity for that period. Accordingly, the assessable income of Companies B, C and D will be included as assessable income for Company A as the head company of the tax consolidated group of which Companies B, C and D are subsidiary members. | Detailed Reasoning - Conclusion: In conclusion, the amounts paid to Companies B, C and D are interest payable under the T(IOEP)A, and are considered assessable income for the purposes of subsection 6-10(1) and section 15-35 of the ITAA 1997. Pursuant to the single-entity rule, Company A, as head company of the tax consolidated group of which Companies B, C and D are subsidiary members will include the Interest Amounts received as assessable income. | Detailed Reasoning - General deductions: Section 8-1 of the ITAA states: You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income. (2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your * exempt income or your * non-assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. (3) A loss or outgoing that you can deduct under this section is called a general deduction. Subsections 8-1(1) and 8-1(2) are also known as the positive and negative limb of the general deduction rule respectively. | Detailed Reasoning - Positive limb - losses or outgoings incurred: To qualify for a deduction under section 8-1 a loss or outgoing must have been incurred. Paragraph 8-1(1)(b) of the ITAA 1997 entitles a taxpayer, where they are carrying on a business, to deduct an amount for a loss or outgoing if it is necessarily incurred for the purpose of gaining or producing assessable income. The Deed and letter stipulates that Companies B, C and D each had an obligation to pay any amount received from the Commissioner in relation to the Tax Dispute to Company E. It is considered that Company A incurred losses or outgoings at the time when Companies B and C paid the Interest Amounts to Company E. In the case of Company D, Company A incurred a loss or outgoing when Company E banked the cheque containing the Interest Amount. The cheque was made payable to Company D making Company D briefly the beneficial holder of the Interest Amount until the cheque was banked by Company E. Therefore for the purpose of the positive limb, it is considered that Company A incurred a loss or outgoing for the purposes of subsection 8-1(1) of the ITAA 1997 when the amount of interest referable to the lnterest Amount was paid to Company E. | Detailed Reasoning - Incidental and relevant character: Macquarie Finance Limited v. Commissioner of Taxation (2005) 2005 ATC 4840 at 52 sets out several general principles regarding the deductibility of interest expense: 1. Interest will ordinarily be an allowable deduction under s 8-1 if incurred in the course of an income producing activity or business. 2. Interest is ordinarily a recurrent or periodic payment securing ``the use of borrower money during the term of the loan''. There may nevertheless be circumstances in which interest will be seen as unrelated to the raising or maintenance of the borrowing and thus, perhaps, on capital account. 3. The question of deductibility is not determined by reference to the label which the parties attach to the outgoing. 4. There must be a borrowing before what is paid can be regarded as interest. That presupposes that the lender is entitled to a return of the money lent. 5. The necessary conditions for deductibility are to be found within the terms of s 8-1. It is not necessary to the deductibility of a perpetual debenture that the transaction be characterised as a loan or a borrowing and the amount paid to debenture holders as "interest''. 6. An outgoing, to be deductible, must be "incidental and relevant'' to the gaining or production of assessable income or the business the purpose of which is the gaining or production of assessable income. There must be a sufficient connection between the outgoing on the one hand and the gaining or producing of assessable income or the business as the case may be. | Detailed Reasoning - A Borrowing: Following the principles set out above, there must be a borrowing or loan before the outgoings from Company A can be considered to be an interest expense. What constitutes a loan is provided in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd (Radilo ), (1997) 72 FCR 300; 97 ATC 4151; where in their joint judgment Sackville and Lehane JJ said: 'A loan involves an obligation on the borrower to repay the sum borrowed. The matter is put this way by Dr Pannam: A loan of money may be defined, in general terms, as a simple contract whereby one person ('the lender') pays or agrees to pay a sum of money in consideration of a promise by another person ('the borrower') to repay the money upon demand or at a fixed date. The promise of repayment may or may not be coupled with a promise to pay interest on the money so paid. The essence of the transaction is the promise of repayment. ...' In the Deed and the letter from Company E to Company F, Company E agreed to make the payments to the Commissioner on behalf of Companies B, C and D, in respect to the assessments they received. It was also agreed that any amounts received by Companies B, C and D in relation to the Tax Dispute must immediately be paid to Company E, without deduction. Based on the above, there is an obligation for Companies B, C and D to repay the amounts that Company E paid on their behalf to the Commissioner. Accordingly the agreement between the parties can be defined as a borrowing. | Detailed Reasoning - Interest: There are numerous cases which consider the meaning of 'interest'. In Firth v. Commissioner of Taxation (Cth) 2001 ATC 4619, Hely J considered interest as, 'a return or consideration or compensation for the use or retention by one person of another's money...' Also in Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 the High Court stated (at CLR 218): '...interest is regarded as flowing from the principal sum…. and to be compensation to the lender for being kept out of the use and enjoyment of the principal sum: ….' As Companies B, C and D agreed to pay any amounts received from the Commissioner to Company E, the additional amounts over and above the repayment of the original amounts paid by Company E to the Commissioner can be considered as compensation to Company E for the use of the money, and therefore classified as interest. | Detailed Reasoning - Incurred in carrying on a business: Having determined that the relevant amount paid to Company E has the character of interest, it is next necessary to consider whether that interest is incidental and relevant to the gaining or producing of Company A's assessable income or the carrying on of Company A's business for that purpose. ATO Interpretive Decision ATO ID 2001/79 (ATO ID 2001/79) provides that interest is deductible under section 8-1 of the ITAA 1997 to the extent that the borrowed funds are used for the purposes of producing assessable income. ATO ID 2001/79 references the 'use test', established in FC of T v Munro (1926) 38 CLR 153 as the basic test for the deductibility of interest, focusing on the use of the borrowed funds as the main criteria. Interest incurred is deductible to the extent that the funds are used in the course of producing assessable income. A deduction can be claimed for interest on a loan to pay a business's income tax. Taxation Ruling IT 2582 (IT 2582) provides: Where a taxpayer carries on a business for the purpose of gaining or producing assessable income and, in connection with the carrying on of that business, borrows money to pay income tax (whether to preserve the assets of the business, maximise the return on them, retain sufficient money to fund the business or otherwise) then it is considered that the interest incurred on those borrowings is a normal incident of conducting that business. That is, such an expense is an expense incurred in carrying on that business... The amounts Company E paid on behalf of Companies B, C and D were part payments to the Commissioner in respect of the assessments received by Companies B, C and D. Accordingly, following the single-entity rule under section 701-1 of the ITAA 1997, Company A as head company of the tax consolidated group of which Companies B, C and D are subsidiary members is considered to have borrowed amounts to pay income tax. Following this, the interest expense incurred by Company A is considered to be an expense incurred in carrying on its business and satisfies the positive limb in subsection 8-1(1) of the ITAA 1997. | Detailed Reasoning - Negative Limb: Under the negative limb of subsection 8-1(2) of the ITAA 1997, Company A is unable to deduct from its assessable income losses or outgoings to the extent that they are of a capital, private or domestic nature, incurred in relation to gaining or producing exempt or non-assessable non-exempt income, or prevented by a provision from deduction. | Detailed Reasoning - Capital Expenditure: A fundamental issue is whether interest can be characterised as a loss or outgoing of capital or of a capital nature. The differentiation between revenue and capital is assisted by a considerable amount of case law. The leading Australian test which distinguishes between revenue and capital outgoings was formulated by Dixon J (as he then was) in Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 ( Sun Newspapers ). In the course of his judgment, Dixon J reviewed both the 'once and for all' and 'enduring benefit' tests of the United Kingdom and then developed his own criteria for distinguishing between revenue and capital expenditure by focusing on the purpose of the expenditure in the context of the taxpayer's business (at 359-360): The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and [on the other hand] the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss… As general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue…For the one concerns the instrument for earning profits and the other the continuous process of its use or employment for that purpose… In applying this test, Dixon J pointed to three relevant factors, although none is in itself decisive at 363: There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. a) Character of advantage sought In regards to the first matter raised in Sun Newspapers , in Steele v DFC of T (1999) 99 ATC 4242 ,(Steele) the Full High Court considers: As was explained in Australian National Hotels Ltd v FC of T , interest is ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but, rather, the use of borrowed money during the term of the loan. According to the criteria noted by Dixon J in Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T it is therefore ordinarily a revenue item. This is not to deny the possibility that there may be particular circumstances where it is proper to regard the purpose of interest payments as something other than the raising or maintenance of the borrowing and thus, potentially, of a capital nature. However, in the usual case,... where interest is a recurrent payment to secure the use for a limited term of loan funds, then it is proper to regard the interest as a revenue item, and its character is not altered by reason of the fact that the borrowed funds are used to purchase a capital asset.'' The payment of interest by Companies B, C and D to Company E secures the use of the borrowing that arose when Company E paid the part payment of tax to the Commissioner on behalf of Companies B, C and D. Therefore based on the above comments in Steele, the interest does not secure any enduring advantage to Company A and the first matter raised in Sun Newspapers points towards the expenditure being revenue in nature and not capital. b) The manner in which the advantage is to be used In relation to the second matter raised in Sun Newspapers, in Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634 Dixon J added the following comments to his criteria in Sun Newspapers at 648: The contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it. What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. In Sun Newspapers, Dixon J indicated that recurrence may play a part in relation to this factor. His Honour provided the following view in relation to the concept of 'recurrence' at 362: But the idea of recurrence and the idea of endurance or continuance over a duration of time both depend on degree and comparison…but "the real test is between expenditure which is made to meet a continuous demand, as opposed to an expenditure which is made once for all" (per Rowlatt J., Ounsworth v. Vickers Ltd. (2)). By this I understand that the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely…Recurrence is not a test, it is no more than a consideration the weight of which depends upon the nature of the expenditure. In Firth v. Commissioner of Taxation (Cth) (2001) 2001 ATC 4615, Hely J considers the form of the interest payment impacting on the revenue or capital character of the expense: Although recurrence is a relevant consideration, it would not alter the situation if the parties chose to have interest paid in a lump sum. The payment of a lump sum interest amount by Companies B, C and D to Company E does not alter the nature of the expenditure i.e. interest and no weight should be given to the absence of recurrence. c) The means adopted to obtain it The last factor looks at the means adopted to obtain the advantage. By this, a distinction is drawn between the provision of a periodical reward or outlay to cover the use or enjoyment of the advantage for periods commensurate with the payment, and the making of a final provision or payment so as to secure future use or enjoyment (Dixon J in Sun Newspapers at 363). The interest incurred by Company A is not made as to secure future use or enjoyment, but rather the use of the borrowing to pay the part payment of tax to the Commissioner. Therefore this factor lends weight to the expenditure being of a revenue nature. For the reasons stated above, the payment of the Interest Amount to Company E is not capital or capital in nature and paragraph 8-1(2)(a) of the ITAA 1997 does not prevent deductibility of the amount to Company A. | Detailed Reasoning - Private and Domestic Nature, Exempt Income, Other Provisions: Based on the above reasons the interest expenditure is not considered a loss or outgoing of a private or domestic nature or incurred for the purpose of obtaining exempt or non assessable income. | Detailed Reasoning - Conclusion: For the reasons stated above, the payment by Companies B, C and D of the Interest Amount to Company E pursuant to the Deed are outgoings of a revenue and not of a capital nature, and are therefore deductible to Company A under section 8-1 of the ITAA 1997.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Subject: Is interest paid considered assessable income: The inclusion in the assessable income of the Head Company (Company A) under subsection 6-10(1) of the Income Tax Assessment Act 1997 (lTAA 1997) and section 15-35 of the lTAA 1997 of amounts of interest received by Companies B, C and D the subsidiary members of Company A's tax consolidated group, from the Commissioner of Taxation (Commissioner) pursuant to the Taxation (Interest on Overpayments and Early Payments) Act 1983 (T(IOEP)A) and the deductibility under section 8-1 of the lTAA 1997 to Company A of certain amounts paid by Companies B, C and D, to the Head Company (Company E) of the tax consolidated group of which Companies B, C and D were formerly subsidiary members.