Private ruling: Interest on loan used to purchase units in unit trust
Date of advice: 5 February 2016
Published: March 2016
Ruling period: Income year ending 30 June 2016 | Income year ending 30 June 2017 | Income year ending 30 June 2018 | Income year ending 30 June 2019 | Income year ending 30 June 2020 | Income year ending 30 June 2021 | Income year ending 30 June 2022 | Income year ending 30 June 2023 | Income year ending 30 June 2024 | Income year ending 30 June 2025
Date scheme commenced: 1 July 2015

Ruling: Q1: Will the interest on a loan used by you and your spouse to acquire units in a unit trust be deductible under section 8-1 Income Tax Assessment Act 1997 (ITAA 1997) where the trust uses the funds to purchase a rental property owned by you and your spouse? | A1: Yes | Q2: If the interest is deductible under section 8-1 ITAA 1997, will Part IVA Income Tax Assessment Act 1936 (ITAA 1936) apply to deny the deduction? | A2: No

Relevant facts and circumstances: You and your spouse jointly own two properties. Property A was purchased in 19XX. Funds borrowed to purchase Property A have been repaid and the property is currently unencumbered. You and your spouse moved out of Property A and it is currently rented to an unrelated party. You and your spouse purchased Property B in 20XX. Property B has been your main residence since settlement. You and your spouse propose to establish a fixed unit trust (the trust). You provided a copy of the proposed trust deed. You and your spouse will each own X% of the units in the trust. As unit holders, you and your spouse will both be presently entitled to income and capital of the trust, subject only to the payment of expenses. The Trustee of the trust will be a company which is yet to be set up. The company will be established for the sole purpose of acting as trustee for the trust. Either you or your spouse or both of you will be director/s of the company. You and your spouse will jointly borrow an amount from a bank or a similar institution. The loan amount and repayments may vary depending on the lender's requirements. The borrowed funds will be used to subscribe for units in the trust. The trustee will guarantee the loan and will allow Property A to be used as security for the loan (see below). Once the trust has been established, the trustee of the trust will enter into a contract of sale of land to purchase Property A from you and your spouse. The sale will be conducted on an arm's length basis. The funds to purchase the property will come from money paid by you and your spouse to purchase units in the unit trust. Stamp duty will be paid by the trustee at full market value. Any capital gains tax applicable to the sale of Property A will be paid by you and your spouse. The trustee will continue to rent the property at market rates to the current tenant or to another tenant that is not related to you. You and your spouse will have a joint 100% offset account attached to the loan used to acquire the units in the trust and all savings and income will be deposited into the offset account in order to save interest. You expect the loan will be fully repaid in X years. The funds received by you and your spouse from the sale of Property A to the trust will be applied against any amounts owing on Property B. The trustee will distribute the income of the trust to you and your spouse after expenses are deducted. The income from the trust is unlikely to exceed the interest on the loan taken out to acquire the units in the trust. The negative difference between the distribution received from the trust and the interest expense from the loan will be used to offset other income of you and your spouse. Periodically the rent on Property A will be assessed and adjusted to market rates. It is expected that the rent will continue to increase and will eventually exceed the interest from the loan. You and your spouse intend to hold the property long term, X years or more. Once the loan used to acquire the units in the trust is paid off, you will consider transferring your units in the trust to a self-managed super fund (SMSF), which you will set up in the future. You have provided your reasons for entering into the proposed transaction. You have provided an alternative arrangement you would enter into if not for this arrangement.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1936 Part IVA Anti-avoidance rules | Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. | In broad terms, Part IVA will apply where the following requirements are satisfied: | • there is a scheme (see section 177A); | • a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C); and | • the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)). | It is determined that Part IVA would not apply to the proposed transactions.

Reasons for decision: Summary: Will the interest on a loan used by you and your spouse to acquire units in a unit trust be deductible under section 8-1 Income Tax Assessment Act 1997 (ITAA 1997) where the trust uses the funds to purchase a rental property owned by you and your spouse? Section 8-1 ITAA 1997 allows a deduction for any loss or outgoing that is incurred in gaining or producing assessable income to the extent that it is not of a private, capital or domestic nature. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following C of T v. Roberts; FC of T v. Smith provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. The ruling specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put. Where a borrowing is used to acquire an income producing asset, or relates to expenses of an income producing activity, the interest on this borrowing is considered to be incurred in the course of gaining or producing assessable income. In your case, you will borrow funds to acquire units in a unit trust. The unit trust will purchase a rental property and will distribute the income of the trust to you after expenses have been deducted. The interest incurred on the loan will be deductible under section 8-1 ITAA 1997. | Detailed Reasoning - If the interest is deductible under section 8-1 ITAA 1997, will Part IVA Income Tax Assessment Act 1936 (ITAA 1936) apply to deny the deduction?: Part IVA ITAA 1936 is a general anti-avoidance provision that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with a scheme, and it can be concluded that the scheme, or any part of it, was entered into or carried out for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. In your case, it is accepted Part IVA will not apply to the proposed transactions. | Summary: The interest on the loan taken out by you and your spouse to acquire units in a unit trust is deductible under section 8-1 ITAA 1997. Part IVA ITAA 1936 will not apply to deny the deduction.