Interest on funds borrowed for capital adequacy not deductible
St George Bank Ltd v FCT (2008) 69 ATC 634
The bank issued a debenture to raise funds (some A$350 million) and interest was payable to the debenture holder. The bank sought to deduct the interest but that was disallowed.
The funds had been raised to be sure that the bank met capital adequacy requirement imposed by the Australian Reserve Bank. Because that was considered to be a purpose of improving the business structure of the bank the deduction was disallowed by the ATO, even though it accepted that the interest had the required nexus with income earning.
The Court (the Federal Court at first instance) held that the payment of interest was part of a capital raising exercise in the US to improve capital adequacy ratios. The interest cost was not related to day to day raising of funds for use in the business but was a cost of ensuring that long term capital (as opposed to circulating capital) was committed to the business.
This is not a satisfactory judgment. A taxpayer may elect to support its business by equity or debt. Debt may be a long term commitment or more short term. One would normally expect the costs of raising long term debt to be deducted because they are usually treated as a charge on the revenue earning process which the debt supports. The Court said in this case that the interest was a cost of acquiring structural advantages, yet such advantages were apparent only in the bank's ability to continue to trade and earn revenue, having satisfied the requirements of capital adequacy.