ATO Interpretative Decision

ATO ID 2006/298 (Withdrawn)

Income Tax

• This ATO ID is withdrawn because the facts and reasons for decision are considered to be incomplete and, therefore, potentially misleading. The Tax Office is considering what guidance on the particular issue dealt with in the withdrawn ATO ID is necessary in order to provide certainty for taxpayers.
  This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

Issue

Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for compound interest incurred on funds borrowed, under a line of credit facility, to acquire an income producing asset?

Decision

Yes. The taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for compound interest incurred on funds borrowed, under a line of credit facility, to acquire an income producing asset.

Facts

The taxpayer took out a line of credit facility, with a financial institution, which was divided into two sub-accounts.

One sub-account was used to acquire an income producing asset (investment sub-account) and the other sub-account was used for non-income producing purposes (private sub-account).

There were no fixed minimum principal and interest repayments required by the lender.

The taxpayer made no payments off the investment sub-account until the private sub-account had been repaid in full.

As interest was capitalised on the investment sub-account, compound interest, being interest on the capitalised interest, accrued on the investment sub-account.

Reasons for Decision

Section 8-1 of the ITAA 1997 allows a deduction for any loss or outgoing that is incurred in gaining or producing assessable income to the extent that it is not of a private, capital or domestic nature.

The deductibility of an outgoing is determined by its essential character (Lunney & Hayley v. Federal Commissioner of Taxation (1958) 100 CLR 478; (1958) 11 ATD 404; (1958) 7 AITR 166).

The character of interest is determined by the purpose of the borrowing. Generally, the purpose of a borrowing can be determined from the use of borrowed funds and outgoings of interest ordinarily draw their character from that use (Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613, Kidston Goldmines Limited v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168).

It is therefore generally accepted that ordinary interest incurred on funds borrowed to acquire an income producing asset is an allowable deduction.

In Hart v. Federal Commissioner of Taxation (2002) 121 FCR 206; 2002 ATC 4608; (2002) 50 ATR 369 it was held that compound interest, as with ordinary interest, derives its character from the use of the original borrowings.

In this case compound interest was incurred on funds borrowed, under a line of credit facility, to acquire an income producing asset. As such, the compound interest was incurred in earning assessable income and is an allowable deduction under section 8-1 of the ITAA 1997.

Year of income:  Year ended 30 June 2006

Legislative References:
Income Tax Assessment Act 1936
   Part IVA

Case References:
Fletcher & Ors v. Federal Commissioner of Taxation
   (1991) 173 CLR 1
   91 ATC 4950

Related Public Rulings (including Determinations)
Taxation Ruling TR 98/22
Taxation Ruling TR 2000/2
Taxation Determination TD 1999/42

Keywords
Borrowings & loans
Deductions & expenses
Interest expenses
Part IVA

Business Line:  Administration, Business and Personal Taxes Centre of Expertise

Date of publication:  27 October 2006

ISSN: 1445-2782