BALDWINS • FoodLegal

Australian Lawyers and Consultants

ATO Rules on Non-deductibility of Interest on Trustee Borrowings to Pay Distributions

April 2003

By Draft Taxation Determination TD 2003/D4 issued on 26/02/03, the Australian Taxation Office seeks to clarify the circumstances under which a trustee of a Trust can obtain a deduction for interest payments incurred on borrowed funds that are used to pay distributions to the beneficiaries.

Principles used by the ATO

In order for interest expense to be deductible, the interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer’s assessable income, and not be of a capital, private or domestic nature.

Undrawn present entitlements

1. Where the beneficiaries may have previously invested money in the income producing operations of a trust, either by subscribing for trust capital, or by allowing income entitlements to remain undrawn; and
2. if the beneficiary calls for the capital or unpaid income to be distributed to him or her; and
3. the trustee borrows money at interest to finance that distribution,

the ATO says the borrowing by the trustee to replace the amount withdrawn by a beneficiary could be characterised as a replacement of money invested in the income-producing operations of the trust, and therefore be tax deductible to the trustee.

According to the ATO, this scenario is more likely to be the case in relation to unit trusts than for non-fixed trusts.

Non-Deductible: internally generated goodwill or unrealised revaluation gain

According to the ATO in TD 2003/D4, a capital account created from internally generated goodwill or an unrealised revaluation of assets merely represents the monetary value of the pre-existing assets of the trust, rather than an investment by a beneficiary in income producing assets of the Trust. According to the ATO, borrowing to make a distribution to a discretionary beneficiary to pay such an entitlement will not be considered as a borrowing incurred for the purpose of gaining or producing assessable income. Rather, the ATO will consider the purpose of the borrowing to be the discharge of the obligation to distribute or to preserve the assets of the trust estate, and on that basis the ATO intends to disallow interest payment deductions on such borrowings.

Great care must now be taken to preserve tax deductibility of interest payments on borrowings, and advice from Baldwins in this regard should be sought, if the client or accountant is in doubt.

For further information, contact Joe Lederman at BALDWINS, Australian Lawyers & Consultants.

Return to the Tax Law Archive.