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Edited version of private ruling
Authorisation Number: 1011495325573
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Ruling
Subject: Interest expenses
Are you entitled to a deduction of 100% of the interest expenses incurred for your overdraft facility?
No.
This ruling applies for the following periods:
Year ended 30 June 2010
Year ending 30 June 2011
Year ending 30 June 2012
Year ending 30 June 2013
Year ending 30 June 2014
The scheme commences on:
1 July 2009
Relevant facts and circumstances
You and your former spouse first used your joint overdraft facility for the purpose of property development.
On completion of the property development the overdraft facility was repaid but not closed.
You and your former spouse later acquired a share portfolio through the re-use of the overdraft facility solely for the purpose of purchasing shares. You later entered into a margin lending arrangement to increase your joint share portfolio.
You and your former spouse borrowed funds from your former spouse's family for the purpose of injecting capital into the margin lending facility due to the downturn in the share market. There were no formal agreements for these loans and no interest charged.
The first loan was paid in full from sale of shares. You and your former spouse partially repaid your second loan to your former spouse's parents from residual funds after the sale of an investment property.
You and your former spouse sold your joint share portfolio as a result of margin calls due to the downturn in the global economy to reduce your borrowings on your margin loan. The margin loan was repaid.
Subsequent to the sale of the shares, an amount was still owed on the overdraft facility.
You and your former spouse signed a court order under the Family Law Act 1975.
You agreed under the Family Law Court Order for your former spouse to transfer the title of the family home to you solely and discharge your former spouse from the overdraft facility, the balance of the loan owing to your former spouse's parents and pay your former spouse a sum of money.
To satisfy the Family Court Order you borrowed from your family members to pay the balance of the loan owing to your former spouse's parents and to pay your former spouse. You then set up a new overdraft facility in your name and closed the joint overdraft facility.
You have provided a copy of the Family Law Court Order and bank account statements.
Reasons for decision
Section 8-1 of the Income Tax Assessment Act 1997 (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.
The general principles relevant to the deductibility of interest expenses are set out in Taxation Ruling TR 95/25. The test is one of characterisation and the essential character of an expense is a question of fact to be determined by reference to all the circumstances.
The character of interest on a loan is generally ascertained by reference to the purpose of the loan (Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613) and the use to which the loan is put (Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153 (Munro's Case).
The 'use' test, established in Munro's Case, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible.
Further, interest on a loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing. That is, when a loan is refinanced, the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities.
Taxation Ruling TR 2004/4 explains where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost and relevant income earning activities have ceased. It states at paragraph 10 that the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion is to be found in whatever was productive of assessable income of an earlier period.
In your case, you refinanced your overdraft facility in your name only. Your original half share of the borrowings from the overdraft facility was used for the purpose of purchasing a share portfolio.
Accordingly, the interest expenses incurred on your new overdraft facility would continue to be deductible for only your half share of the original overdraft facility.
The borrowings undertaken for the other half of the new overdraft facility are as a result of a settlement of the Family Law Court Order and are regarded as being private in nature.
The interest you incur on your new overdraft facility for your former spouse's share of the overdraft is not an expense in gaining or producing your assessable income from your share portfolio or business. It is considered an expense relating to your marriage settlement to discharge your former spouse from the joint overdraft facility and to enable you to transfer title of the family home into your name solely.
Accordingly, you cannot claim a deduction for interest expenses on the portion of the overdraft facility that relates to your divorce settlement.
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