ATO Interpretative Decision

ATO ID 2002/1116

Income Tax

Borrowing costs - Lenders Mortgage Insurance
FOI status: may be released
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CAUTION: This is an edited and summarised record of a Tax Office decision. This record is not published as a form of advice. It is being made available for your inspection to meet FOI requirements, because it may be used by an officer in making another decision.

This ATOID provides you with the following level of protection:

If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.

Issue

Is a premium incurred by a borrower for lenders mortgage insurance, deductible under section 25-25 of the Income Tax Assessment Act 1997 (ITAA 1997) where it is taken out as a condition of a bank loan being approved and the loan is used to purchase an income producing asset?

Decision

Yes. A premium a borrower incurs for lenders mortgage insurance is deductible under section 25-25 of the ITAA 1997 as a cost of borrowing where taking out the insurance is a condition of obtaining approval for a bank loan and the loan is used to purchase an income producing asset.

Facts

The taxpayer purchased an income producing asset financed by a bank loan. The bank loan is solely for the purpose of purchasing the asset and was taken out over a 10 year period.

As a condition of finance approval, the taxpayer was required to take out lenders mortgage insurance by the bank at a cost exceeding $100. A once and for all payment for the lenders mortgage insurance was made at the time the loan was taken out. The insurance policy protects the bank in case of default by the borrower.

Reasons for Decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

Lenders mortgage insurance protects the lender from loss in the event that the borrower defaults on the loan. In the situation where an insurance claim is made, the proceeds are applied to the loan. The insurance does not protect the borrower's capacity to derive income from the asset.

The lenders mortgage insurance premium is a payment to enable an income producing asset to be purchased and is to protect the bank from loss. The payment is not incurred in gaining or producing assessable income. The taxpayer is therefore not entitled to a deduction under section 8-1 of the ITAA 1997.

However, section 25-25 of the ITAA 1997 states that the taxpayer can deduct expenditure they incur for borrowing money to the extent that they use the borrowed money for the purpose of producing assessable income. As the taxpayer is required to take out lenders mortgage protection insurance as a condition of getting finance approval the cost of the insurance is a borrowing cost.

Borrowing costs not exceeding $100 are fully deductible in the year in which they are incurred.

If the total borrowing costs exceed $100, the deduction is spread over the period of the loan or 5 years - whichever is the shorter period.

Subsection 25-25(5) defines the period of the loan as the shortest of:

(a)
the period of the loan as specified in the original loan contract; or
(b)
the period starting on the first day on which the money was borrowed and ending on the day the loan is repaid; or
(c)
5 years starting on the first day on which the money was borrowed.

The method for calculating the deduction for each income year is contained in subsection 25-25(4) of the ITAA 1997.

As the lenders mortgage insurance expense exceeded $100 and the loan was taken out for a 10 year period, the taxpayer is entitled to a deduction spread over 5 years for the cost of the insurance under section 25-25 of the ITAA 1997.

Date of decision:  6 August 2001

Legislative References:
Income Tax Assessment Act 1997
   section 8-1
   section 25-25
   subsection 25-25(4)
   subsection 25-25(5)

Keywords
Rental expenses
Expenses of borrowing
Mortgages
Mortgage expenses
Insurance expenses
Rental property loan interest expenses

Business Line:  Small Business/Individual Taxpayers

Date of publication:  4 December 2002

ISSN: 1445-2782

history
  Date: Version:
You are here 6 August 2001 Original statement
  13 June 2008 Withdrawn