Private ruling: Deduction for interest on funds loaned to on-lend
Date of advice: 20 November 2017
Published: April 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Can you claim a deduction for the interest costs incurred on the amount withdrawn against your home loan to on-lend under section 8-1 of the Income Tax Assessment Act 1997 ? | A1: No

Relevant facts and circumstances: You are an Australian resident for taxation purposes. You are not in the business of providing loans. You entered an arrangement with an individual and their associated company (the borrowers) which outlined the following; ● you would provide funds to the value of $200,000 as an investment into the business ● payment of $100,000 would be made back to you over two years via weekly cash payments ● in the event of a failure of the business or death of the individual you would be paid back the $200,000 plus a profit as agreed ● you had the option of becoming a partner/shareholder in the business in which case the funds would remain in the business to secure your investment You withdrew funds from your home loan to on lend to the borrowers on an ad hoc basis over a period of four months. The funds provided to the borrowers totalled $XXX,000. You were repaid an amount of $X,000 by the borrowers. You sent a demand letter for repayment of the remainder of the funds and then filed a statement of claim. The associated company was placed into external administration but you have advised you have not lodged a proof of debt in the liquidation of the company to secure any available dividend. You filed for default judgment against the borrowers.

Relevant legislative provisions: Section 8-1 of the Income Tax Assessment Act 1997

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 or relate to the earning of exempt income. Taxation Ruling TR 95/25 discusses deductions for interest under section 8-1 of the ITAA 1997. Whether a loss or outgoing satisfies the requirements of section 8-1 of the ITAA 1997 depends on all the facts and matters relating to the loss or outgoing. Paragraph 3 of TR 95/25 includes the following general principles relevant to the deductibility of interest expenses: The interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be capital, private or domestic in nature, and The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower. However, regard must be had to all the circumstances, including the character of the taxpayer's undertaking or business, the objective purpose of the borrowing, and the nature of the transaction or series of transactions of which the borrowing of funds is an element. The essential question is whether the arrangements are consistent with normal commercial practices. Where a person lends money, a deduction for any interest or associated expense incurred will only be allowed where the money is lent on a commercial basis. That is, there must be a reasonable expectation that the person will receive a return. In your case, your borrowed funds were used to on lend to a business. Although a written agreement was entered into, this alone does not change the arrangement to being commercially realistic. It is considered that you did not lend the funds to the borrowers on a commercial basis. This is because ● the written loan agreement between you and the borrowers did not specify an interest rate or a total amount of interest rate to be repaid, ● the written loan agreement between you and the borrowers references repayment of $100,000 over two years and not the whole loan amount, ● there was no action taken by you in relation to the arrears repayments for a period of two years. The amount of assessable income derived from the loan was less than the associated interest expenses and loan fees incurred by you. That is, an overall loss was made as opposed to a profit. Where a borrower does not have the capacity to make regular payments to a loan, a normal commercial lending party would not generally let this situation continue for a period of two years. Although it is stated you believed that the interest would eventually be received by you, it is considered that the arrangement is not commercially realistic. The information supplied and the timeframe of your actions taken to recover repayment arrears does not support your claim of the loan being purely a commercial agreement with an intent to profit. As the loan was not made on a commercial basis, the purpose in lending the money to the borrowers cannot be seen as characterising the expenditure as incurred solely in gaining or producing assessable income. Therefore, you are not entitled to a deduction for the interest expenses incurred on borrowed funds on-lent to the business under section 8-1 of the ITAA 1997.