Private ruling: Deduction and Assessable Income
Date of advice: 13 April 2017
Published: September 2017
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Can you claim a deduction for the settlement payment made to satisfy the loan liabilities? | A1: No | Q2: Is the interest earned from the loan to the other director assessable income? | A2: Yes

Relevant facts and circumstances: You were a director of the Company. The Company was the trustee company for a trust, which ran a business. The business had assets which were obtained by loan. You were a guarantor for the loan. The business had an administrator appointed and in due course the business was liquidated. You and the other director negotiated a settlement payment to satisfy the loan. You share of the settlement was 50%, the other director's share was 50%. However, you paid the full amount from your personal bank account. You then entered into a personal loan agreement with the other director. The loan was made at arm's length. You charged the other director with commercial rate; the loan agreement also has weekly instalments, prepayment and late charge clauses. You are not in the business of providing guarantees

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 6-5

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. The Courts and Tribunals have consistently held that a deduction is not allowable for company expenses paid by directors as they have not been incurred in gaining or producing assessable income in the taxpayer's capacity as a director. The expenses were not incurred by the taxpayer in earning his assessable income but rather the income of the company ( FC of T v. Munro (1926) 38 CLR 153). In Case U134 87 ATC 780; (1987) 18 ATR 3646, expenses incurred on behalf of a family company by a director of the company were not deductible. The expenses had not been incurred in gaining or producing his assessable income in his capacity as a director and there was not a sufficient connection between the expenses and dividend income he received as a shareholder, nor was there a sufficient connection between the expenses and his business of a shareholder holding shares in the family company. Taxation Ruling TR 96/23 Income tax: capital gains: implications of a guarantee to pay a debt at paragraph 45 discusses the deductibility of payments made under guarantee. The ruling states that liabilities that arise under contracts of guarantee will not be deductible under section 8-1 of the ITAA 1997 if the provisions of guarantees and losses or outgoings under the guarantees are not regular and normal incidents of the taxpayers' income earning activities. The ruling further states that if the provision of guarantees is not a regular and normal incident of the taxpayers income earning activities, any payments made under those guarantees will be capital in nature. In your case, you were a guarantee. When the business went into liquidation, you and the other director were required to make payments to satisfy the loan liability. The purpose of the payments was not to directly produce your assessable income but to fulfil your commitment as a guarantor. As you are not in the business of providing guarantees and the purpose of the action was not to produce any assessable income for yourself, you are not entitled to claim a deduction for these expenses under section 8-1 of the ITAA 1997. Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident for taxation purposes includes ordinary income derived directly or indirectly from all sources during the income year. Interest income is considered to be ordinary income for the purposes of subsection 6-5(2) of the ITAA 1997 and is therefore assessable income. In your case, you have entered a loan agreement with the other director. You lent your money to the other director to repay their share of the settlement. The other director pays you the market rate of interest on the funds borrowed. The interest income is regarded as assessable income. Therefore the amount of interest earned from the loan to the other director is assessable as ordinary income under section 6-5 of ITAA 1997.