Private ruling: Income Tax - Deductions - loan interest
Published: June 2015
Ruling period: 1 July 200X to 30 June 20XX.

Ruling: Q1: Is the interest on the bank loan, used to redeem units in the Family Property Trust, deductible to the Property Trust under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. A deduction is not allowable under section 8-1 of the ITAA 1997 as the interest is not incurred in gaining or producing the assessable income of the Family Property Trust.

Relevant facts and circumstances: All the issued units in the Family Property Trust were held by the Family Superannuation Fund as at 30 June 200X. Y and Z X are the only members of the Family Superannuation Fund. The marriage of the members broke down and in the 20XX financial year the member's break down property settlement was finalised. The Family Court ordered that Z be paid $X out of their member account balance in the Family Superannuation Fund. All of the issued units were redeemed in the Family Property Trust by the Family Superannuation Fund and the consideration for the units was made by using funds borrowed by the Family Property Trust from the bank.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Part 3-1 | Section 104-25 | Section 108-5

Reasons for decision: Detailed Reasoning - Interest deductions - general principles: Interest is deductible under section 8-1 of the ITAA 1997 to the extent to which it is incurred in gaining or producing assessable income of the taxpayer or in carrying on a business and is not of a capital, private or domestic nature. In other words there must be a connection between the expenditure and the operations or activities directed to the production of assessable income: Amalgamated Zinc (De Bavay's) Ltd v FC of T (1935) 54 CLR 295; Charles Moore & Co (WA) Pty Ltd v FC of T (1956) 95 CLR 344; FC of T v Smith (1981) 147 CLR 578; Sanctuary Lakes Pty Ltd v FC of T [2013] FCAFC 50. Deductibility of an interest expense depends on the use to which the borrowed money is put. Interest may be deductible where the loan is used to acquire income-producing assets, even if the assets are capital assets such as a property for rental or shares for dividends. The basic test for deductibility was expressed by Brennan J in Ure v FC of T 81 ATC 4100, when he said at p 4104: "An outgoing of interest may be incidental and relevant to the gaining of assessable income where the borrowed money is laid out for the purpose of gaining that income ( FC of T v Munro (1926) 38 CLR 153 at pp 170, 171, 197; Texas Co (Australasia) Ltd v FC of T (1940) 63 CLR 382 at p 468). The laying out of the borrowed money for the purpose of gaining assessable income furnishes the required connection between the interest paid upon it by the taxpayer and the income derived by him for its use." The "use" test was generally endorsed again by Hill J in FC of T v Roberts; FC of T v Smith (1992) 37 FCR 246; 92 ATC 4380; (1992) 23 ATR 494: "As the cases, including Kidston [ Kidston GoldmInes Ltd v FC of T 91 ATC 4538], all show the characterisation of interest borrowed will generally be ascertained by reference to the objective circumstances of the use to which the borrowed funds are put. However a rigid tracing of funds will not always be necessary or appropriate." | Detailed Reasoning - Application to your circumstances: In this instance the purpose for borrowing the funds was for the redemption of units held by the Family Superannuation Fund. The units are an intangible CGT asset (see section 108-5 of the ITAA 1997). The redemption of the units will result in the units being extinguished. As the borrowed funds have not been used for the gaining or producing of assessable income of the Family Property Trust, the interest incurred on the loan is not deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Other matters - CGT event C2: The redemption of units in a unit trust by the trustee results in the end of an asset in terms of CGT event C2, being the units held by the unitholder. Subsection 104-25(1) of the ITAA 1997 describes the circumstances in which a CGT event C2 occurs: "CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset: a) being redeemed or cancelled; or b) being released, discharged or satisfied; or c) expiring; or d) being abandoned, surrendered or forfeited; or e) if the asset is an option - being exercised; or f) if the asset is a convertible interest - being converted." For the unitholder, the consequence of the redemption is that any proprietary or equitable interest conferred by the units is extinguished at the time of redemption, thereby effectively extinguishing the units. For the unit trust, the consequence of the redemption is that there is no acquisition of the units by the trustee as the units are extinguished when redeemed. The superannuation fund will make a capital gain if the capital proceeds from the ending are more than the cost base of the units. A capital loss will be made if the capital proceeds are less than the reduced cost base of the units. | Detailed Reasoning - Superannuation and relationship breakdowns: The Family Law Act 1975 and the Superannuation Industry (Supervision) Act 1993 provide for an interest in superannuation or a super payment to be divided or split by agreement or court order in the event of a relationship breakdown. For members and trustees of self-managed super funds there can be a number of consequences resulting from the relationship breakdown and splitting of superannuation entitlements. An overview of these outcomes is set out in the link below to the ATO website. https://www.ato.gov.au/individuals/super/in-detail/your-situation/super-and-relationship-breakdowns/?page=1