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ATO Interpretative Decision

ATO ID 2006/298
(Withdrawn)
Income
Tax
Deductibility
of compound interest on a line of credit
facility

This ATO ID is withdrawn because the facts and
reasons for decision are considered to be
incomplete and, therefore, potentially
misleading. The Tax Office is considering what
guidance on the particular issue dealt with in
the withdrawn ATO ID is necessary in order to
provide certainty for
taxpayers.

FOI
status: may be released
Status of this
decision: Decision Withdrawn 1 December
2006

CAUTION: This is an edited and
summarised record of a Tax Office decision. This
record is not published as a form of advice. It
is being made available for your inspection to
meet FOI requirements, because it may be used by
an officer in making another
decision.

This ATOID provides you with
the following level of protection:

If
you reasonably apply this decision in good faith
to your own circumstances (which are not
materially different from those described in the
decision), and the decision is later found to be
incorrect you will not be liable to pay any
penalty or interest. However, you will be
required to pay any underpaid tax (or repay any
over-claimed credit, grant or benefit), provided
the time limits under the law allow it. If you
do intend to apply this decision to your own
circumstances, you will need to ensure that the
relevant provisions referred to in the decision
have not been amended or repealed. You may wish
to obtain further advice from the Tax Office or
from a professional
adviser.

Issue

Is the taxpayer entitled to a deduction under
section 8-1 of the Income Tax Assessment Act 1997
(ITAA 1997) for compound interest incurred on
funds borrowed, under a line of credit facility,
to acquire an income producing asset?

Decision

Yes. The taxpayer is entitled to a deduction
under section 8-1 of the ITAA 1997 for compound
interest incurred on funds borrowed, under a line
of credit facility, to acquire an income producing
asset.

Facts

The taxpayer took out a line of credit
facility, with a financial institution, which was
divided into two sub-accounts.

One sub-account was used to acquire an income
producing asset (investment sub-account) and the
other sub-account was used for non-income
producing purposes (private sub-account).

There were no fixed minimum principal and
interest repayments required by the lender.

The taxpayer made no payments off the
investment sub-account until the private
sub-account had been repaid in full.

As interest was capitalised on the investment
sub-account, compound interest, being interest on
the capitalised interest, accrued on the
investment sub-account.

Reasons for
Decision

Section 8-1 of the ITAA 1997 allows a deduction
for any loss or outgoing that is incurred in
gaining or producing assessable income to the
extent that it is not of a private, capital or
domestic nature.

The deductibility of an outgoing is determined
by its essential character ( Lunney &
Hayley v. Federal Commissioner of Taxation
(1958) 100 CLR 478; (1958) 11 ATD 404; (1958) 7
AITR 166).

The character of interest is determined by the
purpose of the borrowing. Generally, the purpose
of a borrowing can be determined from the use of
borrowed funds and outgoings of interest
ordinarily draw their character from that use (
Fletcher & Ors v. Federal Commissioner of
Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991)
22 ATR 613, Kidston Goldmines Limited v.
Federal Commissioner of Taxation (1991) 30 FCR
77; 91 ATC 4538; (1991) 22 ATR 168).

It is therefore generally accepted that
ordinary interest incurred on funds borrowed to
acquire an income producing asset is an allowable
deduction.

In Hart v. Federal Commissioner of
Taxation (2002) 121 FCR 206; 2002 ATC 4608;
(2002) 50 ATR 369 it was held that compound
interest, as with ordinary interest, derives its
character from the use of the original borrowings.

In this case compound interest was incurred on
funds borrowed, under a line of credit facility,
to acquire an income producing asset. As such, the
compound interest was incurred in earning
assessable income and is an allowable deduction
under section 8-1 of the ITAA 1997.

Note: While the general anti avoidance
provisions of Part IVA of the Income Tax
Assessment Act 1936 are not considered
applicable in this case, the application of Part
IVA depends on a detailed analysis of the facts of
each case. The Commissioner considers that a
scheme in relation to a loan facility would need
to have the same features as those set out in
paragraphs 16 to 19 in Taxation Ruling TR 98/22
before Part IVA could be applied.

Date of decision: 5 October 2006

Year of income:

Year ended 30 June
2006

Legislative References:
Income Tax
Assessment Act 1936
Part IVA

Income Tax Assessment Act
1997
section 8-1

Case References:
Fletcher &
Ors v. Federal Commissioner of
Taxation
(1991) 173 CLR
1
91 ATC 4950

Hart v. Federal Commissioner of Taxation

(2002) 121 FCR
206
2002 ATC 4608

Kidston Goldmines Limited v. Federal
Commissioner of
Taxation
(1991) 30 FCR
77
91 ATC 4538

Lunney & Hayley v. Federal Commissioner
of Taxation
100 CLR
478
(1958) 11 ATD
404
(1958) 7 AITR 166

Related Public Rulings (including
Determinations)
Taxation Ruling TR 98/22
Taxation Ruling TR 2000/2
Taxation Determination TD
1999/42

Keywords
Borrowings & loans

Deductions & expenses
Interest
expenses
Part IVA

Date of publication: 27 October 2006

ISSN: 1445-2782

This
work is copyright. Click here for notice
of
copyright.

© Commonwealth of
Australia

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