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Borrowed money to pay a business tax debt? The interest could be deductible.

Posted by: The ADP Team on 19 February 2019 in Finance, Legislation, Tax

Thank you to our guest blog, Tax & Super Australia.

It was in the year 1990 when the ATO was asked for the third time in its history about the tax deductibility of interest on a loan a business had taken out to repay a tax debt.

According to ATO records, the matter was raised as part of two previous requests for clarification — one made as far back as 1951, and the other even further back in time, in 1921.

By the 1990 query, the ATO decided to put the matter to rest and issued a taxation ruling (IT 2582), which has stood ever since. There are however curly caveats and conditions attached.

By way of background, the ATO admitted in its ruling that there were, and are, a number of “practical difficulties” associated with denying such a specific deduction for taxpayers carrying on a business. The difficulty goes right to the heart of the Income Tax Assessment Act 1997, although at the time of the ruling’s issue some of the relevant sections were still in the Income Tax Assessment Act 1936.

Subsection 51(1) of the 1936 act provides that: “All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.”

The “difficulties” the ATO refers to come about due to the fact that paying a tax debt is neither of a capital nature nor done to gain “exempt” income.

The relevant ruling (IT 2582) says: “Where a taxpayer carries on a business for the purpose of gaining or producing assessable income and, in connection with the carrying on of that business, borrows money to pay income tax (whether to preserve the assets of the business, maximise the return on them, retain sufficient money to fund the business or otherwise) then it is considered that the interest incurred on those borrowings is a normal incident of conducting that business.”

The ATO continues: “That is, such an expense is an expense incurred in carrying on that business and hence qualifies for deduction under the second limb of subsection 51(1) of the act.” The ATO adds case law (Begg v FC of T (1937) 4 ATD 257) to give weight to the decision.

Care needs to be taken however, as the ruling would not apply to interest on borrowings that are not connected with the carrying on of a business for the purpose of producing assessable income.

Note however that the ruling does not consider situations where individuals borrow to pay off a tax debt. In these cases, interest incurred by an individual on a loan to pay off a tax debt is not deductible. Before making any claims, consultation with a tax professional is highly recommended.

Do you know the difference between Travel Allowance and the Living Away From Home Allowance (LAFHA)? Take a few minutes to read our blog from TSA ‘Travel allowance or LAFHA? And how is each taxed?’.


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TAGS: Business loans business tax debt Tax