Private ruling: Deductibility of interest expenses incurred by a beneficiary of a discretionary trust on borrowings on-lent with interest to the trustee.
Date of advice: 3 October 2018
Published: November 2018
Ruling period: Year ended 30 June 2019
Date scheme commenced: 28 September 2018

Ruling: Q1: If an individual borrows money from the bank and on-lends that to a discretionary trust with corporate trustee, so the corporate trustee can get cheaper lending for investment purposes, is the individual entitled to claim the interest the bank charges as a deduction? | A1: Yes. Interest expense is deductible under s 8-1 of the ITAA 1997 if and to the extent to which it is incurred in gaining or producing the assessable income or in carrying on a business for that purpose. The deduction is not allowed to the extent to which it is of a capital, private or domestic nature or incurred in gaining or producing exempt income. The fact that the beneficiary derives income from the trust does not provide a sufficient nexus that the on-lending produces income in the trust. However if the trust is paying interest on the loan, it has the character of income. An interest deduction is available where it is expected that assessable income will be derived from making the loan. Where the individual on-lends at a higher rate than what the bank is charging the individual to borrow, an arms-length transaction is taking place. This warrants a deduction due to it being used to produce assessable income. As assessable income is going to be produced, the deduction is allowable. A deduction is available up to the amount of income that is earned from the lending.

Relevant facts and circumstances: A and B are directors of Z. The Z is Corporate Trustee for W. A and B are beneficiaries of W. If Z applied for bank funding, the bank offers an Investment rate, currently around X%. If A and B approach the bank for lending using their owner occupier property as security, they are able to borrow at Y%. You will draft loan agreements between A and B and Z, and the wording would mimic the bank terms to A and B. The bank did not query the purpose of the loan. Multiple financial institutions are able to provide the loan to A and B. The loan will be at market rates.

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