Tax Tip 72: Borrowing to Pay Income Tax and Deductibility of Interest

Here is another private ruling on this topic:
Authorisation Number: 1051642625348
https://www.ato.gov.au/law/view/document?docid=EV/1051642625348

 

The basis of the rulings regarding paying tax using borrowed money require that the tax on the busienss income (only) can be paid by a loan but not other income with another source eg interest, investmnets, CGT excepting small busienss active assets etc So the taxpayer may need to apportion. A taxpayer must by a sole trader of a partner in partnership and then the taxpayer must look at the total income and apportion between buisness elements and other elements.

WARNING : This does NOT apply to trust income even if the trust trades. As a beneficicary of a disc trust has no fixed right to a share of income
A employee Directors etc cant claim a deduction BUT the company could borrow money from the Director and provide there is a basis for charging interest (ie a loan agreement) then the company may deduct the interest.

WARNING : The USE of the borrowed money test should always be considered. Did the person correctly use the borrowed money to pay the tax due or was the chain compromsied ? I have seen instances where a taxpayer accrued a personal debt on PAYG Instalments and sought to boorw to pay that and claim this interest. That is not income tax on business profits. Likewise, borrowing to pay for a personal super contribution (even when self employed) is not a deductible purpose.

 

https://www.ato.gov.au/law/view/document?LocID="TXD/TD200024/NAT/ATO"&PiT=99991231235958

 

What if an individuals taxable income is a mixture of sole trader business income and PAYG employee income. If the individual borrows to pay tax, could the individual claim a deduction on the interest and if so, how much?

 

If you are a sole trader you could potentially borrow to pay the tax related to your business, but not the wage.
seek tax advice.

 

That's the thread we're in
Your tips are a wealth of information btw

I'm not sure if the ATO would accept a proportionate deduction based on the amount of tax payable based on how much tax was payable based on sole trader business income only?

e.g. $200,000 taxable income
$100,000 of this taxable income was due to sole trader business activities

$100,000 tax payable for example.

if you borrowed $100,000 to pay the tax bill @ 10% interest, meaning interest of $10,000. Would the ATO accept a $5,000 deduction of the interest based on the proportion attributed to this business income?

 

Here is another private ruling on this topic:
Authorisation Number: 1051642625348
https://www.ato.gov.au/law/view/document?docid=EV/1051642625348


This private ruling covers this.

 

Ah I see! Would the above apportionment example be deemed appropriate do you think? Do you just ignore the sliding personal income tax scales and how much your business vs your employment income may have contributed in putting you into the top income tax bracket?

 

You should seek your own tax advice on that.

 

The key distinction in that binding private ruling (which cant be used by any other taxpayer)... is

The same approach is applicable to an individual carrying on a business as a sole trader; however it does not apply to interest on borrowings that are not connected with the carrying on of a business for the purpose of producing assessable income.

PAYGW and GST may be incurred by a business activity. However the tax being paid by a sole trader is their PERSONAL tax liability and not that of a business entity who may incur this as part of that operation. Examples of personal tax include income tax and PAYG Instalments of tax. If the sole trader borrowed $$$ to pay employee tax and super then the decision may be more favourable. However, if they have a blended loan with different types of funds borrowed and repaid it may be a complete mess and leave all interest non-deductible. I would always suggest sole traders do not mix income personal tax borrowings with that of other tax issues for a busienss. And for that I have a solution.......

There is a way to avoid this for the PAYGI and personal tax..... If the sole trader runs up a tax debt with the ATO they will charge general interest charge. It is a statutory deduction for a taxpayer. The rate isnt generous. But the deductibiility lessens the pain. It is presently 7.04% compounded daily (0.01928767% per day) but that is less than a card (most) and also less than personal loan rates in most cases. And unlike a bank loan you wont blend the ATO loan account since the statutory deduction applies to 100% of the net debt.

 

Authorisation Number: 5010074273344
https://www.ato.gov.au/law/view/document?docid=EV/5010074273344

Another positive ruling from May 2021
ATO tell a doctor that :
Question

Are you entitled to deduct the interest expenses incurred on borrowings used to pay PAYG instalments tax obligations and/or your year-end tax liability that arise from you carrying on a business?

Answer

Yes.
and add
However, any interest incurred on money borrowed to pay your income tax liabilities that arise from non-business income, such as employment or investment income, will not be deductible under section 8-1 or subsection 25-5(1) of the ITAA 1997. As such, any interest incurred on money borrowed to pay your income liabilities that arise from both business and non-business income will need to be apportioned on a reasonable basis.

 

Yes... One of the problems. I had someone show me how their interest was deductible. They had $100K of income in a busienss schedule and a PAYG job earning similar. eg 50% deductible interest. However the former tax adviser hadnt considered the profit made as a sole trader. They apportioned based on income alone. Taxable income will comprise PAYG income and NET busienss income which should be used. The sole trader activity didnt produce a profit and so none was deductible. Had someone else tell me that since they receive a large % of income from a disc trust that this also met the rules. No....The taxpayer didnt produce the trust income.

I assume its not deductible interest until its determined otherwise.

 

Yes it should be based on profit as tax is only payable on the profit.

But what happens when the profit pushes them up to a higher tax bracket.

Example
Bart has a $120,000 income as an employee doctor. He also does consultations on the side and earns $120,000 for this as a sole trader.

Income tax on the first $120,000 is $31,867
Income tax on the full $240,000 is $83,467
Does this mean his sole trading job is taxed on the different between these 2 figures, which is $51,600?

I don't think so. Both sources would rank equally and it can't be said that one means more tax than the other. The total tax of $83,467 should be divided by 2 and $41,735 can be said to relate to the self employed income.

 

Given Bart would borroow during the year but only determine the interest based on a end of year determination of final net assessable income either method has limits. Private ruling time ?

Its also a issue if Bart had busienss income alone and borrowed to pay taxes, then later varied this and obtained a refund. He may need to discharge the borrowing when that tax is repaid.

 

PBR 1051616287081
https://www.ato.gov.au/law/view/view.htm?docid=EV/1051616287081&PiT=99991231235958

Question 1

Are you entitled to a deduction for interest incurred on money borrowed to pay income tax and PAYG instalment amounts that arise from you carrying on a business?

Answer

Yes.

Question 2

Are you entitled to a deduction for interest incurred on money borrowed to pay your income tax liabilities that arise from your non-business income?

Answer

No.