Private ruling: Deductibility of interest expense
Published: February 2012
Ruling period: Year ended 30 June 2008 | Year ended 30 June 2009 | Year ended 30 June 2010 | Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1July 2007

Ruling: Q1: Are you entitled to a deduction for the interest expenses incurred on the borrowed funds? | A1: No.

Relevant facts and circumstances: Between early 2008 and late 2009 you provided funds to family members. Your family members owned properties at 2 locations. Properties at one of these locations were rented for several years. The money you lent was to refinance some of their existing loans and your intention was to share in the profit from the sales of the properties although this was not formally ratified. They properties were offered for auction in mid 2010 and were sold between mid 2010 and lmid 2011. In late 2010 you and family members signed an agreement regarding the unpaid loans. The terms of the agreement included: · The purpose - Working capital for development and management of the borrower's property portfolio consisting of the properties at the 2 locations. · security of a second ranking mortgage over the properties. · an agreed per annum interest rate , · repayment on demand Following the sale of the properties there were insufficient funds available to repay the loans to you. None of the loans have been repaid and no interest payment has been received. You have continued to incur interest charges for the money that you borrowed to loan to your family members.

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, except where the outgoings are of a capital, private or domestic nature. Taxation Ruling TR 2004/4 considers deductions for interest expenses incurred prior to the commencement of income earning activities and the implications of the decision of the High Court in Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele's case). In Steele's case, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. Taxation Ruling TR 2004/4 concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances: · the interest is not incurred too soon, is not preliminary to the income earning activities, and is not a prelude to those activities, · the interest is not private or domestic, · the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost, · the interest is incurred with one end in view, the gaining or producing of assessable income, and · continuing efforts are undertaken in pursuit of that end. In your case, you lent your family members money over a period of time to refinance their loans to help them with their financial situation. There was an expectation that when their properties were sold they would sell for a profit and you would share in the profit. These properties were sold between mid 2010 and mid 2011. In late 2010 you signed a loan facility document setting an interest rate and giving you a second ranking mortgage on the properties. This arrangement provides for repayment on demand. This loan agreement was made some time after the loans were made and puts in place conditions that were not in place when the loans were made. Additionally, at the time of lending the funds there is no evidence of any security being obtained from the borrower. Initially, you had an informal understanding in place to share in the profits of the sale of some properties. With the downturn in property market, the sale of the properties did not provide sufficient funds for you to be repaid. There has been no repayment of capital or payment of interest. It is considered that the dominant purpose of lending the money was to support your family and their business activities through a difficult financial period. The arrangement was not a commercial undertaking with the purpose to earn an income from lending of money. There is less than a commercial arrangement in place between you and your family members from the time money was first lent by you and the nature of these loans remains unchanged. The arrangement that you have in place with your family members is considered to be private and domestic in nature. Paragraph 8-1 (2) (b) of ITAA 1997 says you cannot deduct a loss or outgoing under this section to the extent that it is a loss or outgoing of a private or domestic nature. Additionally, Taxation Ruling TR 2004/4 which covers interest incurred in a period prior to the derivation of relevant assessable income says the interest is not to be private or domestic. A deduction under section 8-1 of the ITAA 1997 is not allowable for your interest expenses on the funds that you borrowed.

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.