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TRA 02/11
09 Jul 2013
Appeal Status

Interest deductibility and nexus

2013 case note - decision confirms that there must be a direct link between the expense and the income-earning process for nexus to be met – interest deductibility.

TRA 02/11


No direct nexus existed between the payments made by the disputant and the disputant's income-earning process.

Impact of decision

The decision confirms that there must be a direct link between the expense and the income-earning process for nexus to be met.


The disputant ("X Limited") is a loss attributing qualifying company that is in the business of beef and dairy farming. In the 2006 to 2007 income years, the disputant borrowed money from the bank which it advanced to two related companies, on land which it owns and on land that it leases from two related companies ("Y Limited" and "Z Limited"). These companies used the funds to purchase three farms and to repay/refinance an existing loan on another farm. X Limited operated its beef and dairy farming operations from the land purchased by Y Limited and Z Limited (and from land owned by the disputant).

X Limited paid the interest owed on the amounts borrowed from the bank. However, no interest was demanded or paid by Y Limited or Z Limited on the advances made by X Limited. X Limited ultimately claimed deductions for the interest paid to the bank. The Commissioner disallowed the deductions.


Were the funds used directly in the disputant's income-earning process?

The disputant submitted that the borrowed funds were used to acquire land on which the disputant carried on its farming business and, in respect of Y Limited, the borrowed funds were used to acquire farms with associated Fonterra shares. The disputant acquired the benefit of those shares in the form of Fonterra dividends.

The Taxation Review Authority ("the Authority") determined there was no evidence supporting the disputant's assertion that an agreement existed between the disputant, Y Limited and Z Limited, that provided for the acquisition of land and a subsequent lease back to the disputant in exchange for the loans.

The Authority stated that the decision in Case S5 (1995) 17 NZTC 7,036 (TRA) was "directly on point", confirming that the disputant was not in the business of lending money and any benefits to the disputant were derived in its capacity as a lessee of land. Accordingly, the derivation of income by the disputant was an "indirect" consequence of the funds. The Authority agreed with the Commissioner that the provision of loans by the disputant was one step removed from the income-earning process of the disputant.

In addition, the Authority determined that no evidence of any agreement to assign the Fonterra dividends to the disputant was produced but that in any event, even if an agreement had existed, again that income was not derived from the use of the loaned funds.

The Authority also confirmed that assets were owned by Y Limited and Z Limited not the disputant and therefore the advances did not result in the acquisition by the disputant of an income-earning asset.

Barter transaction

The disputant asserted that it obtained a reduction in lease costs as a result of the interest-free loans and therefore a barter transaction existed.

The Authority was not satisfied, on the evidence, that there was any barter arrangement. The Authority determined that in any event, even if an agreement did exist, the interest expense wouldn't have had the necessary nexus to any barter income.

Income Tax Act 2004, Tax Administration Act 1994