Income tax: is interest deductible to a unit holder on borrowed funds used to acquire units in a trust where the distribution received includes amounts which are not assessable income?

If a unit trust, which has no net income for Division 6 purposes, distributes non-assessable income to a unit holder, that amount will be exempt income by virtue of the definition of exempt income in subsection 6(1) of the Income Tax Assessment Act 1936 . The interest expense is not deductible as it fails to satisfy the conditions for deductibility set out in subsection 51(1).

If a unit trust distributes both assessable and non-assessable income, the interest expense is incurred for a dual purpose, i.e., the derivation of both assessable and non-assessable income. The interest expense is apportioned ( Kidston Gold Mines v FC of T 91 ATC 4538) in the ratio of assessable distribution to total distribution to determine the allowable deduction ( Adelaide Racing Club v FC of T (1964) 114 CLR 517 (1992) AAT Case 8229). Example: Distributions received by unitholder X in 1992 from the ABC Tourist Hotel Unit Trust totalled $10,000, comprising $8,000 from the net income of the trust and $2000 accounting income from the operation of Divisions 10C and 10D of Part 111. Unitholder X, who incurred interest expense in the year of $4,000 on funds borrowed to finance the purchase of the units, would receive a deduction of $3,600 under subsection 51(1), ie. the assessable proportion of the distribution is 80% ($8,000 / $10,000 * 100) so that the allowable deduction is 80% of $4,000.