Private ruling: Interest expense on loan
Published: June 2012
Ruling period: Year ending 30 June 2013 Year ending 30 June 2014 Year ending 30 June 2015 Year ending 30 June 2016
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for interest expenses incurred on borrowed funds where the company you advanced the funds to has entered liquidation? | A1: No. | Q2: Are you entitled to a deduction for interest expenses incurred on borrowed funds used to purchase shares on behalf of your superannuation fund? | A2: No.

Relevant facts and circumstances: You and your spouse borrowed funds to make two investments. The loan was secured against your rental property. The borrowed funds were advanced to Company A to invest on your behalf. You have incurred interest expenses on the loan which will be refinanced in the future. Investment one · A portion of the borrowed funds were treated as a loan to Company A to be used in a commercial property development. · Company A on-lent the funds to a related company who used your funds, and those of other investors, to purchase properties and commence development. · The property development was expected to take two years to complete. · You expected to receive a lump sum amount as a return on your loan when the developed property was sold. · The loan was a verbal agreement. · Company A and their related companies entered liquidation Investment two · The remaining borrowed funds were to be used to purchase Company B's shares in your name. · The shares were then to be invested into a superannuation fund. · You were advised that the value of the shares would double. · There is no documentation to show that the shares were purchased in your name originally. · Company B's share register shows the shares are held in the name of the superannuation fund. · No written documentation was created by the financial adviser regarding the proposed or actual transactions.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 51AAA | Income Tax Assessment Act 1997 Section 8-1

Reasons for decision: Summary: You are not entitled to a deduction for the interest expense on your loan as the borrowed funds were used with the intention of earning a capital gain and to earn the assessable income of another entity. | Detailed Reasoning - Detailed reasoning:: You are entitled to a deduction for expenses incurred in earning your assessable income. No deduction is allowable where the expense is of a capital, private or domestic nature or was incurred with the aim of earning a capital gain. Interest on loans is generally deductible where the borrowed funds have been used to earn assessable income. You have borrowed funds and used them to make two investments. | Detailed Reasoning - Investment one: · You and your spouse advanced funds to Company A with the expectation that you would receive a lump sum return. · A lump sum return on advanced funds is considered to be a capital amount and would be assessable to the lender under the capital gains provisions of the tax legislation. Where the lender had borrowed money to be able to advance the funds, any interest expense on the borrowed funds would not be deductible to the lender as the funds were advanced with the intention of earning a capital gain. · As you and your spouse have advanced the funds with the intention of earning a future capital gain, the interest expenses associated with borrowing the funds advanced is not deductible. | Detailed Reasoning - Investment two: · Some of the borrowed funds were used to purchase shares in Company B. · Company B's share register shows the shares are held in the name of the superannuation fund. · As no documentation exists to show the shares were purchased in your name or that you had made a contribution to the superannuation fund, the Commissioner considers that the superannuation scheme is the owner of the shares. · As the shares were purchased in another entity's name, and will earn assessable income for that entity, no deduction is allowable for the interest expense on borrowed funds used to purchase the shares. | Detailed Reasoning - Restructure of loans:: Refinancing of a loan does not affect the deductibility of interest on that loan. If the original loan was used for income producing purposes and the interest was deductible, then the interest on the refinanced loan will also remain deductible. The deductibility of interest on a loan is dependent on how the borrowed funds are used. The security used for the loan does not affect the deductibility of the interest expense. For example, if a loan is secured against an income producing asset but the borrowed money is used for private purposes, no part of the interest expense will be deductible. Similarly, if the loan is secured against the borrower's private residence but the borrowed funds are used to purchase income producing shares, the interest deductible. You intend to refinance the loan when you purchase your home. The interest on the refinanced loan will not be deductible as the interest on the original loan is not deductible.

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.