Property groups and financing costs: The Charles Apartments tax case

Background: property development and financing

Charles Apartments Pty Ltd (‘Charles Apartments’) was a special purpose vehicle within the Demian Group. Its sole purpose was to acquire, develop and eventually sell three adjoining properties in Parramatta, NSW (‘the Properties’). The project was initially funded through a loan from St George Bank (‘the St George loan’) which was subsequently re-financed with a much larger facility from Suncorp (‘the Suncorp loan’) which consolidated borrowings across multiple entities in the group. 

Importantly, Charles Apartments did not borrow directly from Suncorp but instead received an undocumented $3m loan from a group company (‘the intragroup loan’), which it used to repay the St George loan. Charles Apartments was, however, guarantor to the Suncorp loan. The guarantee was structured so that Charles Apartment’s liability was limited to the amount it received from the sale of the Properties.     

In 2010 the development stalled, and the Properties were sold. Charles Apartments executed three contracts of sale, generating $5m, which was used to repay the Suncorp loan. Charles Apartments self-assessed the $5m as assessable income and claimed a deduction for ‘interest’ on the intra-group loan of $1.87m. 

There were other issues regarding the amount of assessable income, but we will focus solely on the interest deductibility issue. 

ATO’s position 

The Commissioner of Taxation reviewed the self-assessment and concluded that the $1.87m was not interest but a payment of a guarantee that was capital in nature and therefore not deductible under s8-1 Income Tax Assessment Act 1997. 

The Tribunal

Charles Apartments sought administrative review by the Administrative Appeals Tribunal (‘The Tribunal’) which decided that the payment was a deductible interest expense to Charles Apartments.

The Federal Court

The Commissioner cross-appealed to the Federal Court which held in favour of the ATO. 

Wheatley J held that:

1. The payment was not appropriately characterised as an interest expense, but was a payment made under a guarantee. The Court emphasised that the payment was not made pursuant to a loan agreement between Charles Apartments and Suncorp – it was made as guarantor, and the liability to make the payment was only to the extent of the proceeds from the Paramatta properties. 
2. The guarantee payment was capital in nature, meaning it was not deductible under s8-1. 
3. In addition, the payment lacked necessary connection (or ‘nexus’) to the income producing activities of Charles Apartment, which is necessary for a deduction under s8-1. The lack of formal documentation regarding the intra-group loan made it difficult for the taxpayer to evidence this nexus. 
4. The Tribunal had misapplied the ‘refinancing principle’. The Tribunal had concluded that the $1.87m payment was a continuation of the St George loan (to which Charles Apartments was a direct party to the loan agreement). The Court rejected this view and held that there was no continuity of borrowing – the absence of documentation and the contingent nature of the liability precluded the application of the refinancing principle. 

Key takeaways for taxpayers

1. Substance over form: The Court rejected the taxpayer’s characterisation of the $1.87m payment as ‘interest’, instead looking at the economic substance of the transaction (which as determined to be a guarantee payment on behalf of a related company). 
2. Nexus is necessary: For a deduction to be allowed under section 8-1, the expense must have sufficient nexus to the taxpayer’s income producing activities. Payments made to satisfy obligations of some other entity in the group, rather than the taxpayer’s own business needs, may not meet this test.
3. Documentation is important: Intragroup loans must be carefully structured and documented. Without this, it creates ambiguity regarding the character of certain arrangements and payments. 

The Charles Apartments case reinforces foundational principles in Australian tax law regarding the deductibility of expenses (i.e. capital v revenue, and the nexus requirement). It also underscores the importance of maintaining written documentation to evidence financing arrangements for taxation purposes.

Please contact your Grant Thornton tax adviser if you wish to discuss this matter further.

¹Charles Apartments Pty Limited v Commissioner of Taxation [2025] FCA 461

Article contributed to by Annelise Kovaleski, Senior Associate – Corporate Tax

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