Private ruling: Deduction for business loan interest after cessation of operations
Published: August 2013
Ruling period: Year ended 30 June 20FF | Year ended 30 June 20GG | Year ended 30 June 20HH | Year ended 30 June 20II | Year ended 30 June 20KK
Date scheme commenced: 1 July 20BB

Ruling: Q1: Are you entitled to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for your portion of interest as per the partnership agreement on a loan taken out for business purposes and the business has ceased operations? | A1: Yes.

Relevant facts and circumstances: The taxpayers operated a business in partnership from 19AA until 19BB. The business ceased operations because it was not financially viable to continue the business. The taxpayers had borrowings in the form of an overdraft facility, which was to provide working capital for the business and used entirely for business purposes. While the partnership was operating, the partnership agreement stated that the partnership split was 70% and 30%. The loan is still in existence after cessation of business. The overdraft was refinanced and consolidated with a home loan at various points in time to take advantage of better terms and conditions. The last point of consolidation was in 20AA. There has been no other refinancing of the loan. The repayments are of principal and interest. The loan is in joint names for a term of 25 years, which is expected to end on a specified year in the future. To date, the taxpayers' financial situation is that one is on full pension and the other is in part time employment. They have not made any further payments towards the loan to lessen the debt other than the minimum payments on the loan

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

Reasons for decision: Summary: Provided the loan maintains its identity and funds have not been applied for private purposes, the borrowings will keep their original purpose. The interest incurred after cessation of the business is deductible. As there was a partnership agreement in place at the time of the business ceasing, the proportion set out in the agreement will stand. That is, one can claim 70% and the other 30% of the business portion of the interest. | Detailed Reasoning - Detailed reasoning: 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. Interest expenses are generally deductible under section 8-1 of the ITAA 1997 to the extent that it is incurred in relation to funds used for an income producing purpose. The Commissioner's view on whether interest deductions are allowable after the cessation of the relevant income producing activity is outlined in Taxation Ruling TR 2004/4. TR 2004/4 considers the implications of the Full Federal Court decisions in Federal Commissioner of Taxation v. Brown 99 ATC 4600; (1999) 43 ATR 1 ( Browns Case ) and Federal Commissioner of Taxation v. Jones 2002 ATC 4135; (2002) 49 ATR 188 ( Jones Case ) . In Browns Case , the taxpayer partners borrowed to acquire a delicatessen. After a number of years of trading, the business was sold at a loss. The proceeds of the disposal were made over to the bank but were insufficient to satisfy the liability fully. There was no entitlement under the relevant loan agreement to repay the loan prior to its term without prior agreement of the bank. In Jones Case , the taxpayer, together with her husband, borrowed money to fund a trucking and equipment hire business. After her husband's death, Mrs Jones sold the assets of the business. The proceeds (plus other amounts on hand) were insufficient to pay out the loan and she was unable to fully repay the loan. Brown and Jones Cases accordingly demonstrate that the occasion of interest expenditure can be found in the relevant income earning activities even where those activities are now defunct and all the borrowings (or assets representing those funds) are lost. Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgment about the nexus between the outgoing and the income earning activities. If the taxpayer: · keeps the loan on foot for reasons unassociated with the former income earning activities; or · makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred, the nexus between the outgoings of interest and the relevant income earning activities will be broken. In this case, the taxpayers had an overdraft facility that was used to provide working capital for their business. The overdraft was of no fixed term and in joint names. After the business ceased, the loan was refinanced and consolidated with a home loan a number of times to take advantage of better terms and conditions. The portion of the loan of which they wish to claim interest deductions originates from the overdraft used to provide working capital for the business. They have kept the loan on foot only because of their inability to repay it sooner. The refinancing of the loan a number of times has been to take advantage of better terms and conditions. In view of the decision in Jones case , the refinancing of the loan is not considered a factor in the deductibility of the interest. Provided the loan maintains their identity and funds have not been applied for private purposes, the borrowings will keep their original purpose. Therefore, the interest incurred after cessation of the business is deductible. As there was a partnership agreement in place at the time of the business ceasing, the proportion set out in the agreement will stand. That is, one can claim 70% and the other 30% of the business portion of the interest.