Private ruling: Application of Part IVA provisions
Published: June 2014
Ruling period: Income year ended 30 June 2014 | Income year ended 30 June 2015 | Income year ended 30 June 2016 | Income year ended 30 June 2017
Date scheme commenced: During the 2014 income year.

Ruling: Q1: Will the Commissioner of Taxation make a determination pursuant to paragraph 177F(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) or apply any other section of the Act to deny the trust a deduction for the whole or part of the interest costs incurred on borrowings to subscribe for shares in the company? | A1: No. | Q2: Will provisions in Part IVA of the ITAA 1936 apply to deny the company the ability to utilise its tax losses under section 36-17 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No.

Relevant facts and circumstances: There are two main entities as rulees for this ruling. One is a company and the other is a trust. The company is a resident private company. On a 50/50 basis with another unrelated entity (which is not a party to this ruling), it owns certain real estate and plant. The real estate is leased to an associated entity which is carries on a business in the property. There is no written lease agreement between the company and this entity. The parties agree from time to time on the amount of the rent. The directors consider that the rent is at market value from their experience in the industry. The company has a third party debt (a bank bill facility). It also has a related party debt which is repayable at call. There is no written agreement for the payment of interest or the repayment of capital in relation to the related party debt. The company has been incurring tax losses for a number of years. The audited statutory accounts for the company for the year ended 30 June 20XX disclosed a deficiency in net assets and the auditors, in their report, expressed concern that there was 'significant uncertainty' regarding the company's continuation as a going concern. It is considered that the need for the company to pay interest on the bank bill is eroding its profitability and is resulting in losses being incurred by the company. As this finance is from a third party the interest expense is unavoidable. An associated trust has a X% ownership interest in the company. There is no intention to dispose of assets or change the ownership structure of the trust and the company in the period that the private ruling has been requested for. The shareholders of the company have made family trust elections. The proposed transaction The company's shareholders, being the trust and an unrelated third party, propose borrowing an amount of money each and applying those funds to subscribe for further shares in the company. The trust may borrow this amount from a commercial lender on commercial terms. The company may also provide the real estate as security for the shareholders' loans. The further shares in the company would be ordinary shares which are the same class as those currently on issue. The company will then apply the money subscribed for the further share capital to retire its existing bank bill facility. The proposed refinancing should result in a number of commercial benefits. The primary purpose for the trust in entering into the proposed transaction is to improve the company's financial position, in particular, ensuring the company is not insolvent, which could have significant consequences for members of the of the company who also sit on other company boards. There is a reasonable expectation that the trust will derive dividend income in excess of the interest expense.

Relevant legislative provisions: Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 subsection 177A(1) | Income Tax Assessment Act 1936 section 177C | Income Tax Assessment Act 1936 section 177CB | Income Tax Assessment Act 1936 subsection 177D(1) | Income Tax Assessment Act 1936 subsection 177D(2) | Income Tax Assessment Act 1936 paragraph 177F(1)(b) | Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 36-17

Reasons for decision: Summary: On the face of it, the trust would be allowed to claim deductions for the interest it incurs on the funds borrowed for the proposed transaction. This would be because the trust would be deriving assessable income from the company in the form of dividends or at least have a reasonable expectation of deriving such income. The interest expense would be deductible under section 8-1 of the ITAA 1997. The broader question is whether access to such deductions would provide a tax benefit to the trust which may lead to the Commissioner making a determination under section 177F of the ITAA 1936 to cancel the tax benefit. Based on the information provided by the applicant, it appears that overall there is a tax benefit that would flow to the trust in relation to the deductions for interest on the borrowed funds if it proceeds with the proposed transaction. However, following a detailed examination of the relevant scheme having regard to the matters listed under subsection 177D(2) of the ITAA 1936 and the commercial benefits of the proposed transaction, it is concluded that the trust would not be entering into the scheme for the sole and dominant purpose of obtaining a tax benefit. The Commissioner will not make a determination under Part IVA of the ITAA 1936 to prevent the trust from claiming deductions for interest incurred stemming from the proposed transaction. It has been assumed that the company will satisfy the continuity of ownership test or alternatively the same business test under Subdivision 165-A of the ITAA 1997 in order to deduct tax losses. The application of Subdivision 165-A does not form part this private ruling. The question is whether access to such deductions would provide a tax benefit to the company which may lead to the Commissioner making a determination under section 177F of the ITAA 1936 to cancel the tax benefit. Based on the information provided by the applicant, it appears that overall there is a tax benefit that would flow to the company in relation to the deductions of tax losses if the proposed transaction is entered into. However, following a detailed examination of the relevant scheme having regard to the matters listed under subsection 177D(2) of the ITAA 1936 and the commercial benefits of the proposed transaction, it is concluded that the scheme would not be entered into for the sole and dominant purpose of obtaining a tax benefit. Provided that the company will meet the requirements under Subdivision 165-A of the ITAA 1997, the Commissioner will not make a determination under Part IVA of the ITAA 1936 to prevent the company from utilising tax losses from previous years.