Income tax: do the principles set out in Taxation Ruling TR 98/22 apply to line of credit facilities?

Yes. The principles and reasoning set out in Taxation Ruling TR 98/22 'the taxation consequences for taxpayers entering into certain linked or split loan arrangements apply to line of credit facilities that are operated as follows: • there are two or more sub-accounts within the line of credit; • at least one sub-account is used for non-income producing purposes and at least one sub-account is used for business or investment purposes; • there is one overarching credit limit; • the lender requires a minimum payment which is equal to the amount of interest which accrues on the whole of the outstanding liability, including the investment sub-account; • no part of the minimum payment is applied to the investment sub-account; • the whole of the minimum repayment is directed to the non-income producing sub-account; and • where a taxpayer does not make any payments on the investment sub-account, interest accrues on both the unpaid principal sum and the unpaid interest.

In this Determination, we refer to the total interest that has accrued on the investment sub-account during the period that all payments are directed to the non-income producing account as 'capitalised interest', and the portion of this interest that has accrued on the unpaid interest in the relevant year as 'the further interest amount'.

The advantage arising to the taxpayer on capitalisation of interest on the investment sub-account is the reduction of the principal amount outstanding under the non-income producing sub-account. Having regard to this advantage, we take the view that the further interest amount does not have the necessary character required for it to be deductible under section 8-1 of the Income Tax Assessment Act 1997 ('ITAA 1997').

Alternatively, having regard to all the circumstances relating to the facility, we take the view that a single liability incurred in respect of interest on the investment sub-account in any particular period serves more than one end, activity or object. We consider that the further interest amount is incurred for the purpose of enabling a corresponding reduction in the non-income producing sub-account.

On this basis, an apportionment of the interest incurred on the investment sub-account in the relevant year is warranted. A fair and reasonable apportionment would be to allow as a deduction under section 8-1 the interest to the extent to which the interest incurred on the investment sub-account in that year exceeds the further interest amount.

If any part of the further interest amount incurred on the investment sub-account is deductible under section 8-1, we would then consider whether the general anti-avoidance provisions of Part IVA are applicable. As the application of Part IVA depends on the facts, the observations below are necessarily subject to the facts of any particular case.

We consider that the scheme would have the same features as those set out in paragraphs 16 to 19 in TR 98/22.

The tax benefit is the difference between the deductible interest incurred on the investment sub-account under the scheme and the deductible interest that would have been incurred on the investment sub-account if payments equivalent to the interest accrued on the investment sub-account were, in fact, allocated to that sub-account. The tax benefit equals that part (if any) of the further interest amount which would have been deductible under section 8-1.

Each case must be considered on its own merits. However, having regard to the eight items listed in paragraph 177D(b) of the ITAA 1936, it is open to a reasonable person to conclude objectively that a taxpayer, who has entered into a scheme with the characteristics outlined in TR 98/22 and paragraph 1 above, did so for the dominant purpose of enabling that taxpayer to obtain a tax benefit. In such a case, it would be appropriate for the Commissioner to exercise his discretion under section 177F to determine that the whole or a part of the interest deduction otherwise allowable shall not be allowable to the taxpayer.

The further interest amount cannot be included in the cost base or indexed cost base for the purposes of the Parts 3-1 and 3-3 of the ITAA 1997 (the capital gains tax provisions).

We discuss the application of relevant principles and authorities in detail in Taxation Ruling TR 98/22.