Private ruling: interest expenses
Published: August 2013
Ruling period: Year ending 30 June 2009 | Year ending 30 June 2010 | Year ending 30 June 2011 | Year ending 30 June 2012 | Year ending 30 June 2013
Date scheme commenced: I July 2008

Ruling: Q1: Are you entitled to a deduction for interest? | A1: No.


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

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. A number of significant court decisions have determined that for an expense to be an allowable deduction: § it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense ( Lunney v. FC of T ; (1958) 100 CLR 478, § there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL v. FC of T , (1949) 78 CLR 47 ( Ronpibon's case) , and § it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income ( Charles Moore Co (WA) Pty Ltd v. FC of T , (1956) 95 CLR 344; FC of T v. Hatchett , 71 ATC 4184). The essential character of an expense is a question of fact to be determined by reference to all the circumstances. Whether you are considered to incur the interest expense needs to be considered. In your case, an interest amount is deducted from the gross fees generated by you. However the gross fees do not belong to you. These fees are owned by entity A. As the interest amount is not paid from your income, you are not actually incurring an interest expense. Whilst it is acknowledged that the interest amount reduces the profit amount the interest expense is not paid from your commission income. The interest amount arises as a result of a contractual agreement with entity A and the associated expense does not belong to you. The fact that you may have to pay an amount if the required profit is not obtained does not alter the fact that you are not entitled to a deduction under section 8-1 of the ITAA 1997 for the notional interest amount.

If you require capital equipment, entity A will pay invoices made out to yourself and charge you back a capital equipment charge equal to instalments of the principal over the relevant depreciation period plus notional interest at a commercial rate. The facility is operated similar to a lease. | Entity A requires a fixed profit to be produced from your efforts and if this profit is not reached you are obligated to make up the shortfall. | All costs incurred by you deplete your ability to obtain this profit margin. | The interest charge is a cost against this fixed profit margin. | The interest is deducted from the gross fees generated by you. | You are engaged as a contractor to operate the business and produce services and be responsible for the costs and profit margin. | The fees are generated for entity A. You do not own the fees or goodwill. | You receive a commission on fees personally generated after fees have been deducted. The interest is not paid from your commission.