Facts

The taxpayer incurred borrowing costs in relation to his investment in units in a Trust.

Under the Trust Deed, the Trustee held the trust fund on trust for unit holders and discretionary beneficiaries on the terms contained in the Trust Deed.

The taxpayer argued that the Trust was a fixed trust and that the interest payments claimed by him were wholly deductible.  He argued that, properly construed, the Trust Deed created a hybrid trust by which:-

• The assets representing the capital subscribed by unit holders in the Trust and all income received by the Trust was held on fixed trust for the unit holders in the Trust, in proportion to the number of units held by each of the unit holders as a proportion of the total number of issued units; and
  
  
• All realised and unrealised capital gains derived by the Trust were held on a discretionary trust for the discretionary beneficiaries.

However, the Australian Taxation Office (ATO) argued that, as a consequence of the operation of the Trust Deed, the Trust was a wholly discretionary trust and that, therefore, the taxpayer had no fixed or present entitlement to income derived by the Trust at the time that he acquired his units or at the time that he paid interest on the loans.

Therefore, the ATO argued that the taxpayer did not incur the claimed interest payments in gaining or producing assessable income in any of the three years of income in question.

Reasons for Decision

The AAT stated that the main issue was the degree of connection between the outgoing (the interest) and the gaining or producing of assessable income.

In determining the essential character of an interest expense, it is necessary to look at both the purpose of the borrowing and the application or use of the borrowed funds.

The AAT rejected the taxpayer’s argument that only his subjective purpose in borrowing the money was relevant, and instead held that all of the objective circumstances surrounding the incurring of the expense, including the terms of the Trust Deed, needed to be considered.

The AAT agreed that the Trust Deed was effectively discretionary and, therefore, the interest was not deductible.