Private ruling: Deduction for interest on loan of funds by property investor trustee on-lent to unit holder
Date of advice: 7 June 2018
Published: August 2018
Ruling period: Financial year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Are you entitled to a full deduction under section 8-1 of the Income Tax Assessment Act 1997 for the interest payments you make relating to your on-lending agreements with your Investor trusts? | A1: Yes, with consideration to the prepaid interest rules.

Relevant facts and circumstances: You are an Australian resident for tax purposes You are a manager for a business and director of a management business. You are not under a legal disability for the purposes of Division 6 of Part III of the ITA 1936. You consider yourself exposed to the threat of litigation as a result of your profession and to acquire assets in your own name exposes these assets to this threat. You and your spouse are the joint directors of companies which are trustee entities to Investor trusts. You and your spouse are general beneficiaries of the trusts along with other persons and entities related to you. You have borrowed funds from the companies, via on lending agreements in your name, to settle funds into the trusts. These on lending agreements are considered to be at arm’s length, commercial transactions. You are incurring expense for the payment of interest on these loans. The trustee companies through the trusts have purchased rental properties and the trusts have issued you units, at market value, as the sole unit holder to the value of the amounts settled. This is reflected in the resolutions of directors to issue A class units inclusive of a formula for income attachment and on the unit certificates, issued to you by the trust and the register of unit holders held by the trust. You have provided copies of; the trust deeds, amendments to the trust deeds, the on lending agreements between yourself and the trusts, unit certificates issued to yourself from the Property Investor Trusts. In the trust deeds you have provided the distribution clause states; a) The trustee shall hold that part of the income (if any) or the revenue income or the non-revenue income as may be applicable, of the Trust Fund that is attributable to each class of unit asset upon trust for the registered holders of the corresponding class of units (as determined pursuant to clause 6.4) in accordance with the rights attached to and in proportion to the number of units held by them respectively. b) Subject to sub-clause (a) the trustee may in each accounting period pay, apply or set aside the whole or such part (if any) of the income of the trust fund of that accounting period to or for the benefit of or for all or such one or more exclusive of the others or other of the general beneficiaries then living in such proportions and in such manner as the trustee may in its absolute discretion determine. This clause entitles you to receive income distributions in accordance with the rights attached to and in proportion to the number of units held by you in preference to other general and residual beneficiaries. Your rights cannot be defeated by any discretion the trustee can exercise in relation to distributions to other beneficiaries.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1936 Section 82KZM | Income Tax Assessment Act 1936 Division 6 of Part III

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. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The essential character of an interest expense is derived from the purpose of the borrowing and the application or the use of the borrowed funds. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. However, a loss or outgoing is not deductible where it is incurred to gain or produce benefits for other persons. The conclusion that borrowed money is being used to benefit entities other than the taxpayer follows logically from the connection between the money spent and the rights the taxpayer and the others obtain. While the deductibility of interest incurred on borrowed moneys settled on trust were considered in Taxation Determination TD 2009/17 - Income tax: is interest on a loan fully deductible under section 8-1 of the Income Tax Assessment Act 1997 when the borrowed moneys are settled by the borrower on trust to benefit the borrower and others? , the Commissioner has issued specific Product Rulings PR 2011/15 and PR 2014/15 Income tax: deductibility of interest in relation to investment in a property Investor Trust, which are applicable to your circumstances. The dates of effect for the PRs are prospective and apply to the specified class of entities that enter into the scheme and whose units in the trust are allotted on or before specified dates. This aside, if the documentation for the schemes you have entered are consistent with the documentation on which the PRs are based then we would consider the application of the rulings even where your applicable dates may not fall into the defined class of entities to which the rulings apply. The schemes in the product rulings are materially different from those considered in TD 2009/17 as they ensure that the present entitlement of the unit holder reflects their fixed rights derived from the asset. Those fixed rights are commensurate to the proportion of the Trust’s capital funded by the unit holder in order for the trustee to purchase the asset, as shown in a formula set out in a Unit Certificate referred to in the PRs. The discretionary element to the hybrid trust also doesn’t enable this fixed entitlement of the unit holder to be defeated. The terms of trust deeds you have provided indicate, at the distribution clause, that you as sole unit holder can reasonably expect to enjoy all of the benefits flowing from the trust capital which you have funded with the borrowed money due to the issue of units based on the amount settled into the trust. You are entitled to receive income and capital in priority to the other beneficiaries by your holding of the class A units and there are no clauses in the deed that defeat this. The product rulings do not consider scenarios where interest has been prepaid beyond the income year in which the expenditure is incurred. Where the interest has been pre-paid there must be consideration given to the pre-payment rules as per section 82KZM of the ITAA 1936 when claiming a deduction for the interest amounts. The borrowed moneys you settled on the trusts are proportionate to the benefits which might reasonably be expected to pass to you under the trust deed. To that extent, the expenditure has an obvious commercial explanation and can be claimed, where prepayment rules allow, as a deduction under section 8-1 of the ITAA 1997.