SAIM10070 - Relief for interest paid: interest in excess of a reasonable commercial rate: examples
Interest in excess of a reasonable commercial rate: examples
Example 1
A loan of 拢100,000 is taken out for 10 years at a rate of 7% (considered to be a reasonable commercial rate)
The loan agreement requires the interest for the entire period 拢70,000 (拢100,000 x 7% x 10 years) to be paid 拢50,000 in year 1, 拢15,000 in year 2 and 拢5,000 in Year 3.
In year one the 鈥榬easonable commercial amount of interest鈥� would be 拢7,000 (拢100,000 x 7%) and this would be the amount allowed for relief. The disallowed amount of interest, 拢43,000 (拢50,000 - 拢7,000) is 鈥榣ost鈥� and will attract no relief now or in the future.
In year two the 鈥榬easonable commercial amount of interest鈥� for that year would be 拢7,000. Since the loan has now existed for more than one year this amount is added to all the interest relieved in previous periods, 拢7,000 giving a total of 拢14,000 for the two years.
拢7,000 has already been relieved in Year 1 leaving 拢7,000 to be relieved in Year 2, therefore 拢8,000 (拢15,000 - 拢7,000) is disallowed in Year 2 and lost.
In Year 3 the interest paid of 拢5,000 is added to the interest relieved so far 拢14,000 giving a total of 拢19,000. This is less than 拢21,000 (拢7,000 x 3) so all the interest paid in the year, 拢5,000, is allowed.
In Years 4 - 10 no interest is paid and no relief is due.
Doing the calculation for each year ensures that where the interest paid in a particular tax year plus the interest paid in earlier years represents no more than a reasonable commercial rate over the whole period to that point, then that interest will be allowable even if it is (at that point) at a rate above a reasonable commercial amount.
Example 2
John borrows 拢100,000 for 10 years on terms under which no interest is paid in the first year, the rate of interest in the second year is 5%, and in the third and subsequent years is 8.125%. Supposing a reasonable commercial rate of interest is still 7%.
In Year 1 no interest is paid and no interest is due.
In Year 2 he pays 拢5,000 (拢100,000 x 5%) which is added to 拢0 paid in Year 1. The resulting figure of 拢5,000 is less than 拢14,000 (拢100,000 x 7% x 2) so all the interest is allowed.
In Year 3 he will have paid an aggregate of 拢13,125 (拢0 + 拢5,000 + 拢8,125) which is less than 拢21,000 (拢7,000 x 3) and therefore all the interest he paid in the year, 拢8,125, is allowed.
Years 4 -10 if these steps are repeated for these later years you will see that all the interest paid in these years (despite being at 8.125%) will be allowable. By year 10 interest of 拢61,875 will have been allowed in previous years (all the interest paid) and the interest in that year, 拢8,125 will bring the total paid to 拢70,000. As this does not exceed 拢70,000 (拢7,000 x 10) all the interest is relievable.