Interest expense: Capital protected products without a separately identifiable put option entered into before 16 April 2003

Where an investor enters into a capital protected product before 16 April 2003 and that product does not contain a separately identifiable put option, is all the interest expense incurred on the capital protected product deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. All the interest paid on such a capital protected product is deductible.

An investor acquires a capital protected product before 16 April 2003. Under the terms of the capital protected product the investor obtains a limited recourse loan to acquire a portfolio of shares and units that are listed on the Australian Stock Exchange. The investor acquires the shares and units for the purposes of deriving future dividend income and trust distributions.

Under the terms of the limited recourse loan, the lender's recourse against the investor in respect of the principal on the loan is limited to the amount which the lender can obtain by enforcing its rights in respect of the shares and units purchased under the capital protected loan arrangement.

The cost of this capital protection feature is reflected in the rate of interest charged on the loan made available under the capital protected product.

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

In Commissioner of Taxation v. Firth (2002) 120 FCR 450; 2002 ATC 4346; (2002) 50 ATR 1 ( Firth's Case ), the Full Federal Court allowed the taxpayer a tax deduction for all the interest charged on a limited recourse loan. In Firth's Case the capital protection feature was integral to the loan and not distinct or severable from it.

On 16 April 2003 the Treasurer announced in Press Release No. 019 (Taxation of Capital Protected Products) that the ITAA 1997 would be amended to ensure that part of the expense on a capital protected product is attributed to the cost of the capital protection feature, is not interest and is not deductible where this cost is capital in nature, in respect of capital protected arrangements, including extensions to existing capital protected arrangements, entered into on or after 9.30am Canberra time 16 April 2003.

In this case, all the interest on the capital protected product is deductible as the capital protected arrangement is: - entered into before 16 April 2003 - is not extended after that time; and - does not contain a separately identifiable capital protection component.