julia said:
To All,
Can I take this thread one step further and ask has anyone with a Hybrid discretionary trust, where they are claiming a personal tax deduction for the interest on buying the units yet distributions from the trust are going to other beneficiaries ever been through an ATO audit. I would like to know what the ATO had to say about the real potential of a profitable return to the fixed interest holders and how that effected their right to claim the interest.
Julia Hartman
[email protected]
www.bantacs.com.au
Hi Julia
NickM pointed this one out the other day...
28993
EDITED VERSION OF NOTICE OF PRIVATE RULING
Authorisation Number: 28993
This Ruling is a 'Private Ruling' for the purposes of Part IVAA of the Taxation Administration Act 1953.
YEAR(S) OF INCOME TO WHICH THIS RULING APPLIES:
Year ended 30 June 2004
TAX LAW:
Income Tax Assessment Act 1997 Section 8-1.
WHAT THIS RULING IS ABOUT:
Is interest deductible on a loan used to purchase units in a Unit/ Hybrid trust?
THE SUBJECT OF THE RULING:
You will establish a unit discretionary trust with a minimal issue of units.
You will borrow an amount from a Bank. These funds will be used to purchase a number of units in a unit discretionary trust.
The trust will use the subscribed capital to purchase a rental property. The trust will provide security for the borrowing against the rental property.
The finalisation of the loan agreement with the Bank and the issue of the units in the unit discretionary trust will occur at the time of the settlement of the property.
The rental property will be a residential property. A rental agreement will be entered into between the Unit Discretionary Trust and a Company providing serviced accommodation. The rental agreement for the property will be for a period of 10 years.
The Company will be responsible for finding tenants for the property and all day to day operations of the property. The level of rental income will be set by the Company independently of the Unit Discretionary Trust, as owner of the property. Any income derived from the Company will be distributed to the unit holder after allowing for the deductible expenses of the trust.
You will be the trustee of the Unit Discretionary Trust.
It is anticipated that the Unit Discretionary Trust will distribute income to you each year as you currently own all the units in the trust.
The property will not be used as your residence.
COMMENCEMENT OF ARRANGEMENT:
1 July 2003
RULING:
Is interest deductible on a loan used to purchase units in a Unit/ Hybrid trust?
Yes. To the extent that the interest is incurred in producing assessable income.
EXPLANATION: (This does not form part of the Notice of Private Ruling)
Deductibility of Interest
Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent to which it is incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for that purpose and is not of a capital, private or domestic nature.
As you were not carrying on a business only the first limbs of section 8-1 are applicable. In order for a deduction to be allowable, the interest expenses that you incurred must have sufficient connection with the gaining of your assessable income.
An outgoing of interest is incidental and relevant to the gaining of assessable income if the borrowed money is laid out for the purpose of gaining that income (Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153).
In determining the deductibility of interest, the courts and tribunals have looked at the use to which the borrowed moneys have been put. For example, interest on borrowed moneys may be deductible where the moneys are used to acquire income producing assets.
The ‘use’ Test
While the main test is the 'use' test, it may also be necessary to consider other factors in particular circumstances, for example where the interest on the borrowings exceeds the return on the investment.
In Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher's Case), which involved a complex and highly artificial annuity scheme, the income derived from the annuity was less than one-eighth of the deduction claimed for interest. The High Court accepted that the interest was deductible to the extent of the income derived. However, beyond that point, the deductibility of the interest had to be determined by weighing up the whole set of circumstances, including the direct and indirect objects and advantages which the taxpayer sought in making the outgoing.
The Court took the view that if, on consideration of all those factors, the whole of the interest could be characterised as 'genuinely and not colourably incurred in gaining or producing assessable income', the interest would be fully deductible. If only part of the outgoing could be so characterised, apportionment between the pursuit of assessable income and of other objectives was necessary.
Taxation Ruling TR 95/33 considers the implications of Fletcher's Case. The ruling states that if an outgoing produces no assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure, including an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing, to determine whether the outgoing is wholly deductible. If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective, then the outgoing must be apportioned between the pursuit of assessable income and the other objective.
Taxation Ruling IT 2684 considers the deductibility of interest on money borrowed to acquire units in a property unit trust. The ruling states that if units in a property unit trust produce for a unit holder no assessable income in a particular income year, and there is no reasonable expectation that assessable income will be produced in the future, no amount of interest is deductible.
The ruling states further at paragraph 9:
An interest expense is not fully deductible in those cases where the expected return from the units, both income and capital growth, does not provide an obvious commercial explanation for incurring the interest. This may arise in situations where the total amount of income and capital growth which can reasonably be expected from the units is less than the total interest expense, especially if the amount of assessable income expected is disproportionately less than the amount of the interest expense.
In the type of situation referred to above, IT 2684 states that it is necessary to carefully examine all of the circumstances of the case, including the direct and indirect objects and advantages sought by the unit holder in acquiring the units and in making the interest outgoing. The ruling states that indirect objects may include private or domestic purposes (for example, Ure v. FC of T 81 ATC 4100; (1981) 11ATR 484 (Ure's Case)), or the manufacturing of a taxation deduction (for example, FC of T v. Ilbery 81 ATC 4661; (1981) 11 ATR 827 (Ilbery's Case)). If it can be concluded that the interest expense is incurred for dual or multiple purposes, it is necessary to apportion the expense.
IT 2684 provides that in determining whether an interest expense has the character of an outgoing incurred in gaining or producing assessable income, the motive of the taxpayer (or the taxpayer's subjective intention) in incurring it may be a relevant factor (Fletcher's Case). The ruling goes on to state:
In a case where the taxpayer's motive or purpose is relevant, it will be necessary to look at the motive or purpose at the time the interest outgoing was incurred (FC of T v. Total Holdings (Australia) Pty. Ltd. 79 ATC 4279 per Lockhart J. at 4283; (1979) 9 ATR 885 at 891).
Interest is incurred day to day (Federal Commissioner of Taxation v. Australian Guarantee Corp. Ltd. (1984) 2 FCR 483; 84 ATC 4642; (1984) 15 ATR 982; per Beaumont J, and Toohey J). Each income year therefore must be considered separately, that is, the extent of apportionment may vary from income year to income year depending on the circumstances of the case.
Situations may arise where in a particular income year interest ceases to be deductible in full and in later income years is either no longer deductible or (because of the need for apportionment) is only deductible in part.
The ruling states further at paragraph 28:
Even if the amount of interest is greater than the amount of assessable income the interest is deductible in full if it is incurred wholly to produce the assessable income. It is immaterial that this situation may prevail for a number of years. Negative gearing does not necessarily preclude the deduction or, of itself, require and apportionment of the interest expense. In this regard a holder of units in a split property unit trust is as a matter of principle, in no different a position from an owner of other kinds of income producing properties eg property held for rental purpose or shares acquired for the purpose of producing assessable dividend income.
Therefore while you continue to hold all the issued units of the trust and all of the income derived by the trust is directed to you, you will be able to claim 100% of the interest expense. If the income from the trust is directed to other taxpayers by way of the discretionary clauses in the trust or through the disposal of some of the units on issue then the interest will need to be apportioned to reflect the proportion of the total trust income received.
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The Register of Private Binding Advice is published as a public record of the binding advice issued by the ATO. Each piece of advice is based on a specific set of circumstances advised to the ATO and the law in force at the time of the advice, and is considered binding only in respect of the person/s or entity/ies on whose behalf the advice was sought. The Register is a historical record of advice provided, and is not updated to reflect changes in the law, withdrawal of advice or any other change in circumstance. Each piece of advice has been edited to avoid disclosing the identity of the person or entity on whose behalf advice was sought and published advice may therefore not disclose all the relevant facts or circumstances on which the advice was based. For these reasons, advice published in this Register cannot be relied upon as precedent for any other person or entity.
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