Private ruling: Income tax - Deductions - Business and professional expenses - Borrowing expenses
Date of advice: 13 November 2019
Published: February 2020
Ruling period: Year ended 30 June 2019 | Year ended 30 June 2020 | Year ended 30 June 2021 | Year ended 30 June 2022 | Year ended 30 June 2023
Date scheme commenced: Year ended 30 June 2019

Ruling: Q4: Should the break fee be included in the cost base of an asset for the purposes of calculating a gain or loss arising from a capital gains tax event? Answer: No

Relevant facts and circumstances: 1. The Taxpayer purchased land (on which the farming businesses are located) and leases the land to entities who conduct farming operations on the land. Entities connected with the Taxpayer currently operate several farming businesses involved in livestock breeding. 2. The Taxpayer purchased further land - Property A (a livestock breeding and farming property). This was subsequently leased to a Trust A to operate a farming business. 3. The Property A purchase was funded through: o a loan from Bank A to the Taxpayer called a tailored commercial facility ( TCF ) amounting to $X million, and o a deposit provided by Trust B of $Y million. 4. Funds from the TCF were also used to provide a loan of about $Z million to Trust A, which was used to buy stock. Interest derived on the loan to the Trust A will be returned as income in the 20X9 income year. 5. The Trust B is a related party of the Taxpayer and also carries on farming operations. 6. Rent derived by the Taxpayer from Trust A during the 20X8 income year was $W million. This leasing arrangement (from the Taxpayer to Trust A of Property A) is ongoing. Bank A's TCF terms 7. The TCF was a fixed rate loan with Bank A which was entered into on X December 20X7 (that is, the drawdown date was X December 20X7) with a maturity date of X December 20Y2. 8. The terms of the TCF were governed by the following documents: o the Letter of Offer dated X February 20X9 ( Letter of Offer ); o Confirmation dated X December 20X7 ( Confirmation ) o Specific Terms - ANZ TCF (November 20X6) ( Specific Terms ). 9. Clause X.4 (titled 'Prepayment') of the Specific Terms provides that: X.4 ...The Borrower acknowledges that if it cancels a Fixed Rate Loan...then it may be required to pay Bank A an amount which Bank A determines is required to compensate Bank A for all costs or losses which Bank A may directly incur because of the cancellation, including without limitation any Premium. 10. Therefore, where a Borrower exits the fixed rate loan arrangements, they need to pay Bank A a 'break fee' calculated with reference to any cost or losses which Bank A directly incurred due to the cancellation of the fixed rate loan arrangements. Exiting Bank A's TCF 11. In February 20X9, the TCF was updated to reflect changes in pricing. 12. The Taxpayer exited the TCF and the fixed rate loan arrangements therein with Bank A in June 20X9 as it found cheaper finance with Bank B. According to the terms in clause 7.4 of the Specific Terms, the Taxpayer was required to pay Bank A approximately $V million as a fee for exiting the fixed rate loan arrangements in the TCF ( break fee ). 13. This break fee was calculated by Bank A based on the net present value ( NPV ) of the out-of-the-money position (fixed rate vs. prevailing reference rate at the time) for all future interest payments on the TCF. The size of the break fee was due to the break fee becoming significantly out-of-the-money vs. prevailing reference rate which had moved lower since the time that the fixed rate was put in place. 14. An email was sent by Bank A on X June 20X9 to confirm that the TCF had been terminated.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 25-25 | Income Tax Assessment Act 1997 section 40-880 | Income Tax Assessment Act 1997 subsection 110-25(3) | Income Tax Assessment Act 1997 subsection 110-35(1) | Income Tax Assessment Act 1997 subsection 110-45(1B) | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: The break fee incurred by exiting the fixed rate loan arrangements under the TCF is deductible under paragraph 8-1(1)(b) of the Income Tax Assessment Act 1997 ( ITAA 1997 ) as it was an expense incurred by the Taxpayer in carrying on the business of renting out farm land for the purpose of gaining or producing its assessable income. | Detailed Reasoning - Detailed reasoning: Deductibility of expenses 1. Section 8-1 of the ITAA 1997 relevantly provides that: 8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income. Note : Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income. 8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your * exempt income or your * non-assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. For a summary list of provisions about deductions, see section 12-5. 2. A nexus must be shown between an outgoing and the derivation of assessable income ( Ure v. F.C. of T. 80 ATC 4264). Carrying on a business 3. Section 995-1 of the ITAA 1997 defines the term 'business' to mean: any profession, trade, employment, vocation or calling, but does not include occupation as an employee. 4. To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law. 5. In the High Court case of Hope v. Bathurst City Council (1980) 144 CLR 1, a business was described in the following ways: It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character. ...activities engaged in for the purpose of profit on a continuous and repetitive basis. Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit...manifested the essential characteristics required of a business. 6. Further, at paragraph 14 of Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? ( TR 2019/1 ) it states that: It is not possible to definitively state what amounts to a business, however in Federal Commissioner of Taxation v Murry [[1998] HCA 42] Gaudron, McHugh, Gummow and Hayne JJ observed: ...A business is not a thing or things. It is a course of conduct carried on for the purpose of profit and involves notions of continuity and repetition of actions. 7. The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? ( TR 97/11 ) which uses the following indicators to determine whether a taxpayer is carrying on a business: · whether the activity has a significant commercial purpose or character; · whether the taxpayer has more than just an intention to engage in business; · whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity; · whether there is repetition and regularity of the activity; · whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business; · whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit; · the size, scale and permanency of the activity; and · whether the activity is better described as a hobby, a form of recreation or a sporting activity. 8. According to paragraph 16 of TR 97/11, in determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour ( Ferguson v. FC of T (1979) 37 FLR 310 at 325). | Detailed Reasoning - Applying the law to your circumstances: 9. Section 8-1 of the 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. 10. The Taxpayer is in the business of purchasing and subsequently leasing out farm land to entities (such as Trust A) to carry out farming operations in return for rental income. The rent derived by the Taxpayer forms its assessable income. 11. The TCF was taken out by the Taxpayer to finance the purchase of Property A. Property A was subsequently leased to Trust A (to carry out livestock breeding and farming operations), in return for rental income. The break fee was incurred when the Taxpayer exited the fixed rate loan arrangements in the TCF in order to seek a cheaper source of finance and should not be characterised as capital, private or domestic in nature. Therefore, the break fee was an expense incurred by the Taxpayer in gaining or producing its assessable income. | Summary: 12. The break fee incurred by exiting the fixed rate loan arrangements in the TCF is not deductible under section 25-25 of the ITAA 1997 as the TCF did not proceed and it was therefore not expenditure incurred for borrowing money. | Detailed Reasoning - Detailed reasoning: 13. Section 25-25 of the ITAA 1997 relevantly provides that: 25-25(1) You can deduct expenditure you incur for *borrowing money, to the extent that you use the money for the *purpose of producing assessable income. In most cases the deduction is spread over the *period of the loan. For the cases where the deduction is not spread, see subsection (6). | Detailed Reasoning - Note:: Your deductions under this section may be reduced if any of your commercial debts have been forgiven in the income year: see Subdivision 245-E. 14. Subsection 995-1(1) of the ITAA 1997 defines 'borrowing' as: any form of borrowing, whether secured or unsecured, and includes the raising of funds by the issue of a bond, debenture, discounted security or other document evidencing indebtedness. 15. If a loan does not proceed, the associated borrowing expenses are not deductible ( Case Q61 83 ATC 319). Therefore, a deduction is not allowable under section 25-25 of the ITAA 1997 unless the money is in fact borrowed. 16. Paragraph 7 of Taxation Ruling TR 2019/2 Income tax: whether penalty interest is deductible ( TR 2019/2 ) also states that: Penalty interest is not incurred for borrowing money so is not deductible under section 25-25. | Detailed Reasoning - Applying the law to your circumstances: 17. Section 25-25 of the ITAA 1997 allows a deduction for expenditure incurred in borrowing money where the borrowed money is used by the taxpayer for the purpose of producing assessable income. 18. Even though the break fee was incurred in respect of the fixed rate loan arrangements in the TCF with Bank A, the break fee wasn't used to borrow further money as it was utilised by the Taxpayer to exit the fixed rate loan arrangements under the TCF. Therefore, it cannot be said that the break fee with Bank A was used to produce the Taxpayer's assessable income as further borrowing under the TCF did not in fact proceed. 19. Further, in TR 2019/2, the Commissioner considers that a penalty interest payment, such as in the present situation where the Taxpayer refinanced its loan with Bank A to obtain a lower interest rate with Bank B, is not expenditure incurred for borrowing money. 20. Therefore, a deduction under section 25-25 of the ITAA 1997 would not be applicable in respect of the break fee. | Summary: 21. The break fee incurred by exiting the fixed rate loan arrangements in the TCF is not deductible under section 40-880 of the ITAA 1997 as it is already deductible under paragraph 8-1(1)(b) of the ITAA 1997 and because it is not capital expenditure. | Detailed Reasoning - Detailed reasoning: 22. Subsection 40-880(1) of the ITAA 1997 states that: The object of this section is to make certain *business capital expenditure deductible over 5 years, or immediately in the case of some start-up expenses for small businesses, if: (a) the expenditure is not otherwise taken into account; and (b) a deduction is not denied by some other provision; and (c) the business is, was or is proposed to be carried on for a *taxable purpose. | Detailed Reasoning - Note:: If Division 250 applies to you and an asset: (a) if section 250-150 applies - you cannot deduct an amount for capital expenditure you incur in relation to the asset to the extent specified under subsection 250-150(3); or (b) otherwise - you cannot deduct an amount for such expenditure. 23. Paragraph 10 of Taxation Ruling TR 2011/6 Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues ( TR 2011/6 ) relevantly states: · It is a provision of last resort. In other words, section 40-880 only applies to expenditure if no other provision allows or denies a deduction or otherwise takes the expenditure into account. · The expenditure must be capital expenditure which is business related. This excludes revenue expenditure and non-business expenditure such as expenditure relating to occupation as an employee or to passive investment. | Detailed Reasoning - Applying the law to your circumstances: 24. As noted above at paragraph 11 and TR 2011/6, the break fee is not of a capital nature. Rather it is characterised as being an expense of a revenue nature that is incurred in gaining or producing the assessable income of the Taxpayer. 25. Further, section 40-880 of the ITAA 1997 is a provision of last resort and only utilised where other taxation provisions are not applicable. 26. Therefore, the break fee incurred by exiting the fixed rate loan arrangements in the TCF is not deductible under section 40-880 of the ITAA 1997 as it is already deductible under paragraph 8-1(1)(b) of the ITAA 1997 and because it is not a capital expenditure. | Summary: 27. The break fee should not be included in the cost base of an asset for the purposes of calculating a gain or loss from a capital gains tax ( CGT ) event as it has already been deducted as an expense pursuant to paragraph 8-1(1)(b) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 28. CGT asset is defined in section 108-5(1) of the ITAA 1997, which relevantly states that: 108-5(1) A CGT asset is: (a) any kind of property; or (b) a legal or equitable right that is not property. 108-5(2) To avoid doubt, these are CGT assets: (a) part of, or an interest in, an asset referred to in subsection (1); (b) goodwill or an interest in it; (c) an interest in an asset of a partnership; (d) an interest in a partnership that is not covered by paragraph (c). | Detailed Reasoning - Note 1:: Examples of CGT assets are: · land and buildings; · shares in a company and units in a unit trust; · options; · debts owed to you; · a right to enforce a contractual obligation; · foreign currency. | Detailed Reasoning - Note 2:: An asset is not a CGT asset if the asset was last acquired before 26 June 1992 and was not an asset for the purposes of former Part IIIA of the Income Tax Assessment Act 1936 : see section 108-5 of the Income Tax (Transitional Provisions) Act 1997 . 29. Subsection 995-1(1) of the ITAA 1997 defines CGT event to mean: any of the CGT events described in Division 104 [of ITAA 1997]. A CGT event described by number (for example: CGT event A1) refers to the relevant event in that Division. 30. The cost base of a CGT asset has five elements and subsection 110-25(3) of the ITAA 1997 provides that: The second element is the *incidental costs you incurred. These costs can include giving property: see section 103-5. | Detailed Reasoning - Note:: There is one situation to do with options in which the incidental costs relating to the CGT event are modified: see section 112-85. 31. Incidental costs are defined in subsection 110-35(1) of the ITAA 1997, which relevantly provides that: ...they are costs you may have incurred: (a) to *acquire a *CGT asset; or (b) that relate to a *CGT event. 32. However, subsection 110-45(1B) of the ITAA 1997 provides that: | Detailed Reasoning - Deductible expenditure excluded from second and third elements: 110-45(1B) Expenditure does not form part of the second or third element of the cost base to the extent that you have deducted or can deduct it. | Detailed Reasoning - Applying the law to your circumstances: 33. According to subsection 110-45(1B) of the ITAA 1997, when an expenditure has been deducted by another provision of the ITAA 1997, it does not form part of the cost base of a CGT asset. 34. Therefore, as the break fee has already been deducted as an expense pursuant to paragraph 8-1(1)(b) of the ITAA 1997, it will not form part of the cost base of an asset for the purposes of calculating a gain or loss from a CGT event.

Question 1: Is the break fee under the tailored commercial facility deductible under section 8-1 of the Income Tax Assessment Act 1997 ? | Question 2: Is the break fee under the tailored commercial facility deductible under section 25-25 of the Income Tax Assessment Act 1997 ? | Question 3: Is the break fee under the tailored commercial facility deductible under section 40-880 of the Income Tax Assessment Act 1997 ?