Private ruling: Deduction - Interest - Non-forestry MIS
Published: September 2017
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for interest incurred on your loan that was taken out to finance your investment in the project? | A1: Yes. | Q2: Will interest that is charged on a loan to pay the settlement be deductible? | A2: Yes.

Relevant facts and circumstances: You registered a subscription in a project. You financed your investment through a loan and you complied with the terms of the loan. The group operating the project was placed into administration and subsequently liquidation. You sought legal advice and joined a class action. You were advised to stop repayments on your loan and not to claim any further interest deductions in your tax returns, while the legal proceedings were ongoing. Interest has been accruing on your loan at the higher interest rate, in accordance with the terms of the loan agreement. You entered into a settlement arrangement with the group. You have taken out a loan to settle the amount with the group that will incur interest charges.

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

Reasons for decision: Summary: Product Ruling PR xxxx/xx , explains how a Grower's participation in the Project constituted the carrying on of a business of primary production by the Growers and outlined the deductions under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) they were entitled to claim. Even though this product ruling has now been withdrawn and ceased to have affect after 30 June 20XX, the Ruling continues to apply in respect to the relevant provision(s) ruled upon for those entitles who entered into the specified scheme prior to withdrawal. The ruling confirms that interest incurred on loans taken out to fund participation in the Project, is an allowable expense when it is incurred. The group was placed into administration and subsequently liquidation; the income producing activity has now ceased. However, the interest continues to be deductible in your circumstances as we accept you meet the relevant requirements detailed in Taxation ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities. In regards to the accrued unpaid interest on the loan, Taxation Determination TD 2008/27 Income tax: is the deductibility of compound interest determined according to the same principles as the deductibility of other interest? states that compound (or capitalised) interest, as with ordinary interest, derives its character from the use of the original borrowings. Accordingly you are entitled to a deduction for the interest you incur as its character follows that of the original borrowing, which is in respect of earning assessable income. Therefore, you are entitled to claim a deduction for the interest accruing on your loan in the years it has been incurred. Taxation Ruling TR2004/4 outlines the deductibility of interest when it is incurred after assessable income. Where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period. 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. An outgoing of interest in such circumstances will not fail to be deductible merely because: ● the loan is not for a fixed term; ● the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty; ● or the original loan is refinanced, whether once or more than once. However, 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. A legal or economic inability to repay is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities. Where a business activity has ceased, ongoing interest will continue to be deductible. This is unless an event or circumstance occurs to break the connection between the loan and the business activity. Where a borrower obtains separate finance (new loan) to repay all or part of their existing loan they will be able to claim a deduction for interest incurred on the new loan under section 8-1 of the ITAA 1997 provided that, immediately prior to obtaining the new loan, the existing loan was considered to be connected to an income producing activity such that the interest on the existing loan was deductible. As was stated by a full court of the Federal Court in Placer Pacific (Davies, Hill, Sackville JJ): …provided the occasion of a business outgoing is to be found in the business operations directed towards the gaining or production of assessable income generally, the fact that that outgoing was incurred in a year later than the year in which the income was incurred [sic] and the fact that in the meantime business in the ordinary sense may have ceased will not determine the issue of deductibility. The Commissions finds in this case the interest you incur on the loan you have taken out to pay the settlement amount will be deductible under section 8-1 of the ITAA 1997. The refinancing of the loan has not broken the connection to the income earning activity even though the business activity has ceased.