Private ruling: Deceased estate: interest expense to exercise testamentary opti
Published: April 2014
Ruling period: Year ended 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2012

Ruling: 1. Is all of the interest on your borrowings, used to pay out your siblings in order for you to inherit the whole of the estate, tax deductible? | No. | 2. Is the portion of the interest on your borrowings (used to pay out your siblings in order for you to inherit the whole of the estate) that relates to the value of the income producing assets inherited (most specifically the shares) compared to the entire estate, tax deductible? | Yes.

Relevant facts and circumstances: Your parent passed away and their estate consisted of their pre-CGT shares in their private company, a superannuation death benefit and non-income producing personal assets. The conditions of their will were you will inherit the entire estate subject to your paying your siblings a certain amount of money. Otherwise, the entire estate is sold and divided equally between you and your siblings. As a result, in order to inherit the entire estate, you decided to borrow money to pay your siblings.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 128-15 | Income Tax Assessment Act 1997 Section 128-20 | Income Tax Assessment Act 1997 Section 134-1

Reasons for decision: Summary: Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that it is incurred in gaining or producing assessable income except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in FC of T v Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest. It looks at the application of the borrowed funds as the main criterion. Taxation Ruling IT 2606 is about deductions for interest on borrowings to fund share acquisitions. It provides, as a general rule, that interest on money borrowed to acquire shares will be incurred in gaining or producing assessable income where it is expected that dividends or other assessable income will be derived from the investment. Taxation Ruling TR 2004/4 allows deductions for interest expenses incurred following the cessation of relevant income earning activities where a taxpayer can demonstrate a legal or economic inability to repay the loan is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities. Paragraph 50 provides, for example, the decision to realise shares and use the proceeds to purchase a leisure yacht rather than make a repayment of the relevant loan would be highly suggestive of a break of any previously existing nexus. Item 4 of subsection 128-15(4) of the ITAA 1997 provides if a deceased person acquired an asset before 20 September 1985, a legal personal representative or beneficiary who inherits that asset is taken to have acquired it at market value on the day the deceased person died. Section 128-20(1) of the ITAA 1997 provides a CGT asset passes to a beneficiary in an estate if the beneficiary becomes the owner of 104-35(1) of the asset under the will. However, section 128-20(2) of ITAA 1997 provides a CGT asset does not pass to a beneficiary in an estate if the beneficiary becomes the owner of the asset because the legal personal representative transfers it under a power of sale. Taxation Ruling IT 2664 (about the transfer of assets to beneficiaries in deceased estates) was withdrawn under the rationale that the law in respect of the issues dealt with in IT 2664, namely, section 128-20 of the ITAA 1997, is now clear. However, its withdrawal does not necessarily negate its view that where an asset is bought by a grantee of a testamentary option exercised by the grantee the property comes into the ownership of the grantee as a purchaser and not as a beneficiary. Section 134-1 of the ITAA 1997 operates to include the exercise price of an option in the cost base of the asset acquired from the exercise of the option. In your case, subsection 128-20(2) of ITAA 1997 deems you purchased the relevant shares under a power of sale from the estate's legal personal representative as a result of exercising a testamentary option. Since subsection 128-20(2) of ITAA 1997 and section 134-1 of the ITAA 1997 apply to your case, your borrowings will be for the ordinary acquisition of shares as an income producing asset and thus the related interest expenses will be deductible under section 8-1 of the ITAA 1997. As for superannuation death benefit, interest deductions in relation to this would be an allowable deduction only for the period the superannuation death benefit was earning interest income for you. As for the personal assets, since they are not income producing, the interest accrued in relation of your portion of borrowing to acquire them is not deductible.