On 20 June 2018, the ATO released a Tax Determination, TD 2018/9 (Determination), to provide guidance on the deductibility of interest expenses incurred by a beneficiary of a discretionary trust on borrowings on-lent to the trustee of the trust on an interest-free basis.
The Determination clarifies that when a person borrows money (First Loan), and then lends part or all of that money to the trustee of a discretionary trust to which they are a beneficiary (Second Loan) without charging interest on the Second Loan, the interest expenditure incurred in relation to the First Loan is not usually deductible under section 8-1 of the Income Tax Assessment Act 1997(1997 Act), subject to certain exceptions.
Section 8-1 of the 1997 Act allows a taxpayer to deduct any loss or outgoing that is necessarily incurred in producing assessable income or in carrying on a business with a view to producing assessable income.
However, there is one exception to this Determination which would enable a taxpayer to deduct all or part of the interest expenditure incurred under the First Loan, where:
- the beneficiary is presently entitled to the income of the trust estate at the time the interest expense on the First Loan is incurred; and
- the expense has a nexus with the income to which the beneficiary is presently entitled.
Therefore, in making this Determination, the ATO is providing clarity that the overriding purpose of section 8-1, namely that deductions are only permitted for expenditure incurred in pursuit of income personally assessable to the taxpayer, will apply to transactions involving trusts where the taxpayer may not be presently entitled to the income or where there is an insufficient connection between the expenditure and the assessable income derived.
The ATO also noted that, with respect to an early trustee resolution, an irrevocable resolution made by a trustee of a discretionary trust in which the trustee exercises a power of appointment is not considered to be a present entitlement in the hands of the beneficiary until that income is received by the trustee and is legally available for distribution (i.e. the trustee cannot distribute money not in present possession of the trust).
If you would like to discuss the application of this ruling and the deductibility of interest to your or your client’s circumstances, please contact a member of our tax team.