The sale proceeds went straight to the group’s bank. The extra over the original loan was called interest. Characterisation follows substance.
A property development special purpose company tried to deduct about $1.87m it said was “interest” under s 8-1 ITAA 1997. The Full Federal Court said no, a reminder that characterisation follows substance, not labels.
Charles Apartments Pty Ltd v Commissioner of Taxation [2025] FCAFC 180.
The facts
CAPL borrowed $3m from St George to buy and develop properties for sale. The wider group later moved to a $27m Suncorp facility, with another group company, West Apartments, as borrower.
Funds were on-lent within the group so CAPL could pay out St George, grant Suncorp a first mortgage, and guarantee West Apartments’ debt. Post-GFC, West Apartments defaulted. A Forbearance Deed made CAPL and others “obligors” and Suncorp demanded asset sales.
When CAPL sold, the entire net proceeds of about $4.87m went directly to Suncorp to reduce the group facility. CAPL said the “extra” over $3m was interest and deductible.
Why it failed
CAPL leaned on the refinancing principle (Roberts & Smith): refinance a revenue borrowing and the new interest can keep the original character. So, St George borrowing, intragroup “refinance”, interest on sale should be deductible.
The Tribunal’s “but for” approach was wrong. “But for paying Suncorp we could not settle and earn income” skips the s 8-1 enquiry: nexus and character.
The payment reduced West Apartments’ debt to Suncorp. Even if an economic component looked like capitalised interest, the liability discharged was not CAPL’s alleged intragroup interest.
Facts and cashflow killed the story. There was no proven chain of CAPL paying its intragroup lender, principal plus interest, with that sum then going to Suncorp. Settlement documents showed a direct payment to Suncorp, because Suncorp could dictate the flow.
Why capital
Under s 8-1 you do not get a deduction for an outgoing of capital. Applying Sun Newspapers, the Court looked at the advantage sought and the liability discharged.
CAPL’s real advantage in paying Suncorp was to forestall enforcement, avoid Suncorp enforcing its mortgage or calling on the guarantee, and reduce its exposure as guarantor and mortgagor. That is a one-off, structural protection of the taxpayer’s capital position, not a recurring working expense. An “undissected” lump sum paid in reduction of group indebtedness under a guarantee and mortgage was therefore capital in nature.
What we can learn
In groups, always ask who is the borrower and whose liability is being reduced. The answer often decides revenue versus capital.
Refinancing arguments need evidence: loan terms, clear payment flows, and nexus to the taxpayer’s own income-earning activities. If sale proceeds are applied to release securities, manage default or reduce guarantee exposure, expect capital treatment risk, even if someone calls part of it “interest”.
General information only. This note was accurate when written. The law may have changed since and the note is not updated. It is not legal or tax advice, does not take account of your circumstances and must not be relied upon as a substitute for advice on your own matter. If the issue is live for you or your client, email arda@nortonquaytaxlaw.com.au for advice on the current position.