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The general principles of deductibility of an outgoing, such as interest depends on the taxpayer meeting certain criteria in incurring the expense:
A common example of when interest is deductible includes the interest on a mortgage for an investment property that is used to gain or produce assessable income. But if you were to use the investment property for private purposes, then you need to look at the deductibility of the interest for the income year.
In Advanced Holdings Pty Ltd v Commissioner of Taxation [2021] FCAFC 135 (‘Advanced Holdings’), a multitude of issues was considered by the Full Federal Court on appeal, including the deductibility of interest from a loan obtained during the Global Financial Crisis (‘GFC’).
Background
Advanced Holdings Pty Ltd was the trustee for The Demian Trust, which was a part of a larger group associated with property developer, Charbel Demian. The trust was involved in developing property in Inner Sydney. In 2003, a further trust, the Lewisham Estate Trust (who trustee was Lewisham Estates Pty Ltd) was established as a unit trust with Advanced Holdings (in their capacity as trustee) being the initial unitholder.
Between 2003 and 2005, the Lewisham Estate Trust acquired 3 properties in Lewisham, Sydney. The properties were acquired through loans from NAB and Capital Finance. During the GFC, Advanced Holdings came close to defaulting on their loans with NAB and Capital Finance. In 2006, Advanced Holdings was able to refinance with Abacus Funds Management Ltd (‘Abacus’). Abacus became the Demian Group’s main financier across a range of activities beyond the Lewisham Estate Trust. A further loan was provided in 2010. In addition, Lewisham Estate Trust entered into a call option agreement with Abacus in April 2010. In June 2010, Abacus exercised its call option under the agreement, resulting in Lewisham Estate Trust entering a joint venture agreement with Abacus.
Taxpayer argument
Advanced Holdings argued that Lewisham Estate Trust was in the busines of property development, and therefore the properties in Lewisham were trading stock. They argued that the properties had been acquired through borrowed funds. They argued that because the borrowings were used to purchase trading stock (the properties), the refinancing of the loan should retain the revenue character of the original loans.
Court decision
The court disagreed with the taxpayer’s contentions. The Court stated that while the evidence showed that the Lewisham Estates Trust borrowed funds to acquire the properties for their business activities, the actual use of the borrowed funds from Abacus was unclear. The Court founds that the Abacus loan was not only a substitution for the prior loans, but also agreement for access to the capital profit-earning structure of the Demian Group. The Abacus loans were seen as a ‘save’ for the Demian Group entities after near collapse during the GFC.
Due to the ‘capital’ characterisation (as a result of the larger Demian group), the interest was found to be not deductible.
Lessons from Advanced Holdings
When refinancing your loans, it is important to maintain records and ensure that the new loan obtained is related to ‘revenue’ aspects of your business – and not for the use of capital expenses, especially when the loan is supporting a larger group of entities. Deductibility of interest – which can add up in an income year- needs to be considered prior to lodgement of your tax return.
How can Tax Controversy Partners help you?
Firstly, it is important that you consider your position as early as possible if you are facing are unsure on the treatment of interest in your entity or group.
Obtaining legal advice is important, as specialist tax lawyers we can provide you with detailed advice on your circumstances and guide you through engagement with the ATO.
At Tax Controversy Partners, our experienced lawyers can represent your best interests in providing advice that is compliant with the current case law and ATO actions.
Please contact us to help using our online contact form, via email at admin@taxcontroverypartners.com.au or by phone at 02 8513 3813.