Interest Deductions - Borrowing to pay tax

A common question I'm always asked is "Can I claim a deduction for borrowings to pay my income tax bill?"

It depends. The question of when interest incurred on borrowings used to pay a tax bill as a deduction came up for a Ruling in 1920, 1951 and even as recent as 1990 (IT 2582). The 1990 view continues to this day.

s51(1) of the old tax act (ITAA36) considers an outgoing incurred in the producing of assessable income, or necessarily incurred in carrying on a business...shall be deductible.

The 1990 ruling considered that it paying a tax debt is neither capital expenditure nor done in producing exempt income. The outcome is that where the taxpayer carries on a business no action shall be taken by the ATO to deny a deduction attributable to that part of a loan or overdraft that is equal to an amount that is income tax paid out of the account .

For some taxpayer who may satisfy the claim that their property investment is on sufficient scale to be considered a business this may mean that they can utilise loans drawdown to pay taxes and claim the resulting interest. However this comes with a caution - Many IP owners will NOT be able to establish that their scale is that of a business.

A prudent taxpayer may seek a ruling on their circumstance so that they have confidence their deduction claim is valid. A ruling is likely to be requires as there is no specific ATO guidance on what constitutes a business of IP rental. A block of apartments may. A single dwelling or two not.
 
Doh ! Its my annual July "paying your tax using borrowings" article....I trust my comments reflect theirs....I haven't recd it yet.

My emphasis is always upon meeting the business test - Which'then doesn't exist.
 
The ATO approach is a pragmatic one.

Quite simply, if you have a business utilising a working account then an occasional temporary borrow to pay a tax bill will not require apportioning (rigid tracing).

Do not simply expect that a business can borrow to pay tax. That is too simplistic.

Do not expect that the ATO will allow interest on a separate loan taken out to pay an income tax bill/instalment without getting advice/rulings.

Do not expect the ATO to accept capitalisation of interest etc. on a long term borrow to pay income tax.

Sadly, any minor pragmatic concession given by the ATO seems to be read by some taxpayers in an overly optimistic way.
 
Rob - Yes a wise view of not blindly assuming that because it is a business that the interest is deductible. I do encourage IO loans for business tax borrowings to avoid capitalising issues.

I recently saw a capitalised interest problem where ATO denied all the deduction in what would otherwise have been deductible. The taxpayer appeared to engineer a inflating loan with interest capitalised and at same time directed surplus cash as loans to another entity. Like all loans, a tax loan needs to demonstrate the character of being repaid. On review the ATO accepted a straight line deduction excluding any compounding.
 
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