Borrowing to Pay a Tax Debt - Check the Deductibility of Interest
Borrowing to repay a tax debt?
Think the interest on the borrowing will be tax deductible?
Think again ...
Taxpayers, both individual and business entities, have obligations to pay amounts of income tax, GST, PAYG Withholding and Instalments, among numerous other Federal, State and local taxes. For many and varied reasons, taxpayers may not be able to meet these obligations when they are due. This is evidenced by the amount currently owed to the Australian Taxation Office (ATO) in July 2025 is approx. $50 billion.
The ATO charges interest, known as ‘General Interest Charge’ (GIC) on unpaid tax liabilities, and separate ‘Shortfall Interest Charge’ (SIC) where an amended return creates an increased taxation liability.
The current GIC interest rate (as at 1 August 2025) is 10.78%, compounding daily. If you can borrow at a lower interest rate, you may prefer to take out a loan and directly or indirectly use the proceeds to repay or pay down your personal or business tax debt.
Another reason to pay off/out your tax debt is that GIC and SIC are no longer tax deductible from 1 July 2025.
So, if you could save money by borrowing from a bank or financier to pay a tax debt at a lower interest rate than the GIC, this would be good incentive for those who have the capacity to borrow for this purpose.
If you could obtain a tax deduction for the interest on this loan, considering the GIC and SIC imposed by the ATO are no longer tax deductible, this may be considered an even greater benefit.
So, how could the interest on borrowed funds to pay a tax debt be tax deductible?
What makes any type of expenditure tax deductible? To answer these questions, we need to review the relevant sections of the Income Tax Assessment Act 1997 (ITAA1997).
The general deductibility provisions are in section 8.1:
INCOME TAX ASSESSMENT ACT 1997 - SECT 8.1
(1) You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
So, if your interest expense meets the one or both of the above requirements, you then need to ensure none of the below criteria apply:
(2) However, you cannot deduct a loss or outgoing under this section to the extent that:
(a) it is a loss or outgoing of capital, or of a capital nature; or
(b) it is a loss or outgoing of a private or domestic nature; or
(c) it is incurred in relation to gaining or producing your exempt income or your non - assessable non - exempt income; or
(d) a provision of this Act prevents you from deducting it.
The specific provision of the ITAA1997 that relates to the payment of interest on borrowings to pay a tax debt is section 25.5(2)(c) – Deductions for tax related expenses:
INCOME TAX ASSESSMENT ACT 1997 - SECT 25.5
Tax - related expenses
(1) You can deduct expenditure you incur to the extent that it is for:
(a) managing your tax affairs; or
(b) complying with an obligation imposed on you by a Commonwealth law, insofar as that obligation relates to the tax affairs of an entity; or
…..
No deduction for certain expenditure
(2) You cannot deduct under subsection (1):
(a) tax; or
(b) an amount withheld or payable under Part 2 - 5 or Part 2 - 10 in Schedule 1 to the Taxation Administration Act 1953 ; or
(c) expenditure for borrowing money (including payments of interest) to pay an amount covered by paragraph (a) or (b); or …
(emphasis added)
You can see from the above summary that no tax deduction is available for the payment of the primary tax, and interest on borrowings to undertake this are specifically non deductible under this section of ITAA1997.
It follows that an individual taxpayer, not operating a business, is unlikely to be able to obtain an income tax deduction for the interest on personal borrowings to directly repay their income tax liability.
The general deductibility of interest on borrowings at the commence and cessation of a business is discussed in TR2004/4.
So the question then arises – when would a business taxpayer be able to claim an income tax deduction for interest on borrowings, where the loan funds may have been applied either directly or indirectly to pay an income tax liability?
The key to the deductibility of interest on any borrowing is the purpose of the borrowing and/or use of the loan funds.
The security provided for the loan is irrelevant (TD 93/13). For example, there would be no deduction available where funds were borrowed for a residential main residence, using the security of a commercial investment property, as the use of the funds was for a non income producing purpose of buying a home.
Examples of where the interest on borrowed funds may be deductible include:
- Borrowing for business working capital and cash flow (overdraft);
- Borrowing to acquire income producing assets (including from a related party), but note there is no deduction available for the purchase of vacant land until it commences to generate income;
- Borrowing to pay unpaid present entitlements to beneficiaries of a trust;
- Borrowing to repay loans previously provided by related parties to the business.
All of the above scenarios could result in the borrowed funds being in the hands of the business or individuals to enable them to pay their tax liabilities.
A review of the balance sheet of the business with the tax liability, or a related business that holds the security, may provide a guide to the possible purposes of the borrowings. What liabilities (apart from tax) does this borrower have? Could the new borrowings repay existing loans to related parties, making those funds available to the individual or other entities to meet their taxation liabilities?
Are the borrowings an opportunity to acquire assets at market value from other members of the group, considering the taxation and risk implications of sale/purchase of the assets, to place cash in the hands of those who require the funds?
When the business that holds the assets to be used as security plans to borrow funds and on-loan some or all of the funds to a related entity to pay a tax debt, the deductibility of interest will be determined by the nexus between the borrowing entity and the application of the borrowed funds. Commerciality is a key determinant when funds are on-lent from one party to another related entity. A commercial rate of interest should be applied to any internal loans between related parties, taking account of the risk and costs of the borrower/lender, to support the deductibility of interest paid to the external financier.
When considering borrowing to repay a tax debt:
- - All information provided by the borrower to the financier may be supplied to the ATO in future, so please ensure that you are clear as to the commercial/business purpose for the borrowing, while also disclosing to the financier where some or all of the funds will subsequently be used to meet a taxation liability of the business or related party;
- - Ideally the new borrowings would be a separate loan and not mixed with existing tax deductible debt. Where a portion of a loan is not tax deductible, all repayments and interest must be apportioned to determine the tax deductible interest and principal reductions. Where the loan is a combination of tax deductible and non-deductible debt, you also can’t simply pay off the non-deductible portion of the loan – every repayment must be apportioned. Contrast this with having a separate loan (for example, secured against the same property) – you have the ability to repay this separate loan in full at a faster rate.
Where the ATO has imposed GIC and SIC on a taxpayer, we recommend writing to the ATO to request remission of the interest imposed. ATO quick code QC33808 provides guidance regarding the information to include in the remission request. https://www.ato.gov.au/individuals-and-families/your-tax-return/if-you-disagree-with-an-ato-decision/dispute-interest-or-penalties/remission-of-interest-charges
It is essential that you include in your request:
- The situation that caused the ATO interest and the request for remission;
- When the situation has been/will be rectified;
- What has been done to mitigate this situation occurring again;
- Detail the amount of interest to be remitted or the compromise you suggest.
Conclusion
Before borrowing to repay a tax debt, you should review the reason the business has not been able to repay the debt in the first place – are these circumstances continuing (which may result in the additional borrowing causing further business stress) or have trading conditions improved so that the business can meet this new cash flow obligation in additional to its ongoing ATO tax liabilities.
It is essential that you speak to your accountant before undertaking this step – apart from providing some cash flow projections based on your trading results to date, they will be familiar with your circumstances and may be able to recommend a simple strategy/borrowing suggestion to enable the interest on the borrowings to have a high likelihood of being considered tax deductible.
Michelle Wilson
4 August 2025
