Private ruling: interest deductions and part IVA
Published: June 2014
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: 1 July 2013.

Ruling: Questions and answers | 1. Are you entitled to a deduction for interest incurred in connection with the additional units you purchased in the Unit Trust? | Yes. | 2. To the extent that you are entitled to a deduction for interest expenses under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), will section 177D of the Income Tax Assessment Act 1936 (ITAA 1936) apply and the Commissioner make a determination under section 177F(1)(B) to cancel the tax benefit derived by you? | No

Relevant facts and circumstances: The Unit Trust was established in a previous income year in order to acquire family assets and investments. A Company is the corporate trustee of the Unit Trust. You together with relatives are the directors of A Company. You and a relative obtained a loan to purchase the units in the Unit Trust. Another relative is also included on the loan documentation, but they do not own any of the units in the Unit Trust. You currently hold x units in the Unit Trust and a relative holds y units. The Unit Trust used the funds to purchase a property (the property). The property together with your and another relative's principal residence were used as security for the loan. Settlement of the property occurred, and from that date, a relative has been living in the property as their main residence. You advised that the reason for acquiring the property through the unit trust arrangement rather than in the individuals' own names was to: • provide asset protection for the individuals concerned (via the corporate trustee arrangement); • provide easier succession planning if one of the individuals wished to transfer some or all of their units in the trust at a future date; and • minimise estate planning issues - ie when the units are eventually passed on to other family members. A relative has entered into a rental lease with the Unit Trust for the property. Rent is being paid at the rate of $w per month. A copy of the loan application indicates that the Bank assessed the full market rent for the property to be approximately $z per month. The loan is interest free for a couple of years, and then reverts to interest and principal. For the 2014 income year, the trust expects to make a net loss on the rental.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 section 177A | Income Tax Assessment Act 1936 section 177C | Income Tax Assessment Act 1936 section 177CB

Reasons for decision: Detailed Reasoning - Interest deduction: Section 8-1 of the ITAA 1997 provides a taxpayer with a deduction for a loss or outgoing to the extent to which it is incurred in gaining or producing the taxpayer's assessable income. A loss or outgoing is not deductible to the extent that it is of a private or domestic nature (paragraph 8-1(2)(b) of the ITAA 1997). You have, jointly with other family members, borrowed funds to purchase units in a unit trust. The unit trust has used the funds to purchase a rental property. Therefore you will be entitled under section 8-1 of the ITAA 1997 to a deduction for the interest incurred to the extent to which it is related to the gaining or producing of your assessable income (ie expected distributions from the unit trust). | Detailed Reasoning - General anti-avoidance provisions - the application of Part IVA of the ITAA 1936: Part IVA of the ITAA 1936 applies to a scheme where, having regard to a number of objective factors or matters, it would be concluded that one of the scheme participants who entered into or carried out the scheme or any part of the scheme did so for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme. A 'scheme' is defined in subsection 177A(1) of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan or proposal. The factual arrangement described above (ie the taking out of the loan, purchase of units in the unit trust, subsequent purchase of a property and rental of that property to the son) will constitute a 'scheme'. Under section 177C of the ITAA 1936 a tax benefit received in relation to a scheme will include an amount for a deduction being allowable where that deduction would not have been allowable, or might reasonably be expected not to have been allowable if the scheme had not been entered into. Part IVA was amended in 2013 to insert section 177CB which applies in relation to schemes entered into after 15 November 2012. Under subsection 177CB(3) when postulating what might reasonably be expected to have occurred in the absence of a scheme, the alternative must represent a reasonable alternative to the scheme in the sense that it could reasonably take the place of the scheme. In your case, a reasonable alternative to the scheme would be for you, and your relative, to purchase the property in your own names - that is, without interposing the unit trust. Under this alternative postulate, you would still be entitled to a deduction for the interest to the extent that it was incurred in generating assessable income (ie the rental income from your relative). Therefore, there is no tax benefit under the scheme. Accordingly, Part IVA will not apply.