A recent Taxation Review Authority (‘TRA’) case serves as a reminder not to be complacent when it comes to lending arrangements between associated entities. One of the fundamental questions to be asked is “what has the entity used the funds for”, to determine whether or not there is the required connection between the expenditure and income derived.

In a recent TRA case, the taxpayer was a farming company that borrowed funds from the bank and on-lent them to other companies in which the company had an interest. The funds were subsequently used to purchase additional farms, which were then operated by the taxpayer. Resolutions were signed by the shareholders and director, but there was no written agreement in respect of the on-lending itself. Interest was payable on demand, but no demand was made.

The taxpayer claimed a deduction for interest paid to the bank. The interest deductions were disputed by IRD and were the subject of the TRA case – and the IRD won.

The taxpayer argued that the interest expenditure had been incurred in the income earning process, in the form of a reduced lease charge for the farm land by way of a barter type arrangement. The TRA disagreed, finding that there was not a sufficient nexus between the interest expense and any benefit to the business activities of the taxpayer. Any additional income would come as a result of the increased farming activity and not the borrowed funds.

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