Private ruling: Income tax: interest expense deductions and Part IVA
Published: December 2014
Ruling period: 1 March 2014 - 30 June 2014 | 1 July 2014 - 30 June 2015 | 1 July 2015 - 30 June 2016 | 1 July 2016 - 30 June 2017
Date scheme commenced: Expected commencement during the 2013-14 income year

Ruling: Q1: Will the Commissioner of Taxation make a determination pursuant to section 177F(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) or apply any other section of the Act, to deny the trustee for Trust A a deduction for the whole or part of the interest costs incurred on borrowings to subscribe for shares in the company? | A1: No

Relevant facts and circumstances: The company is a resident private company with the trustee for Trust A and an unrelated entity each having 50% ownership in the company. The company owns 50% of certain real estate and plant (with the remaining 50% owned by an unrelated entity). The real estate is leased to an associated entity which carries on a business in the property. There is no written lease agreement between the company and the associated entity. The parties agree from time to time on the amount of 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). The company has a related party debt. There is no written agreement for the payment of interest or the repayment of capital in relation to the related party debt. The debit is repayable at call. 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 2013 disclose a deficiency in net assets and the auditors expressed concern that there was significant uncertainty regarding the company's continuation as a going concern. It is considered that these borrowing costs are contributing to the erosion of the company's profitability and therefore a transaction has been proposed which will enable the company to retire the bank bill facility. The proposed transaction involves the following steps: • the company's shareholders (the trustee for Trust A and the unrelated third party) propose borrowing an amount each and applying those funds to subscribe for further shares in the company; • the shareholders may borrow this amount from a commercial lender on commercial terms; • the company may provide the property 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; and • the company will then apply the additional 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 trustee for Trust A 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 company who also sit on other company boards.

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)

Reasons for decision: Summary: On the face of it, the trustee for Trust A would be allowed to claim deductions for the interest it incurs on the funds borrowed under 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 trustee for Trust A in relation to the deductions for interest on the borrowed funds if it proceeded with the proposed transaction. However, following a detailed examination of the relevant scheme, having regards to the matters listed under subsection 177D(2) of the ITAA 1936 and the commercial benefits of the proposed scheme, we conclude that the trustee for Trust A would not be entering into the scheme for the sole or dominant purpose of obtaining a tax benefit. The Commissioner will therefore 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.