Edited version of private ruling

Authorisation Number: 1011546593247

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Ruling

Subject: Business deductions-Interest expense

Are you entitled to apportion loan repayments against the private portion of a loan that was raised for a business and non-business purpose pursuant to subsection 8-1 of Income Tax Assessment Act 1997 (ITAA 1997)?

No.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You purchased land.

The property comprised a residence on some of the land and the remainder is to be used as a rural business.

The total cost of the property was $XXXX and after allowing for legal fees, stamp duty and other costs, you borrowed $XXXX.

Real estate valuations undertaken indicate that the residence and attached land are worth $XXXX and the business portion $XXXXX.

You sold your previous residence for $XXXX and wish to use the net proceeds to reduce the loan balance owing on the private portion only of the single $XXXX loan.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Interest is deductible to the extent to which it is incurred in gaining or producing assessable income or in carrying on a business for that purpose and is not of a capital, private or domestic in nature (s8-1 ITAA 1997). In determining the deductibility of interest, the courts and tribunals have looked at the purpose of the borrowing and the use to which the borrowed moneys have been put (TR 2004/4). The security given for the borrowed money is irrelevant (TD 93/13).

Where a loan is taken out for two purposes, one business and one non-business, only a proportion of the interest will be deductible under section 8-1 ITAA 1997 (TR 95/33).

However, in Carberry's case, a married couple was allowed a deduction for the full amount of interest on a loan used to purchase a combined dwelling/child-minding business where it was shown that the whole of the loan related to the purchase of the business and the dwelling was purchased with proceeds from the sale of the previous home.

IT 2661 accepts the approach adopted by the Federal Court in the special circumstances of the case. It accepts that a single asset may be capable of being properly regarded as having been notionally divided between a part acquired with a business purpose and a part acquired with a non-business purpose.

IT 2661 goes on to say:

13. However, for this method of apportionment to apply, it must be shown that the borrowings in fact relate solely to the notional part of the asset acquired for business purposes. In Carberry, for instance, the taxpayers were able to show that the part of the asset purchased for private purposes was paid for with the monies which the taxpayers had received from the sale of their previous residence. Accordingly, it was open to the Tribunal to find that part of the asset purchased for business purposes was in fact purchased with the borrowed funds.

This is very specific and does not indicate that repayments can be directed towards a certain notional portion. TR 98/22 deals with the deductibility of interest under 'linked or split loan' facilities. The ruling indicates that repayments to mixed purpose loans can't be directed to the notional private part.

TR 2000/2 indicates that repayments of principal are generally applied proportionately against the outstanding income-producing and non-income producing balances, except where borrowed money is recouped (for example, of the sale of an asset purchased with the borrowed money) or a mixed-purpose debt is refinanced.

The Commissioner has consistently applied the above principal in similar cases with the ATO view that Carberry's case does not provide authority that payments made in respect of a single dual purpose loan can be applied solely to the income-producing or private portions of the loan.

Accordingly, TR 2000/2 says at paragraph 16:

16. Where interest accrues daily under a mixed purpose sub-account, a taxpayer is entitled to a deduction in respect of that part of the interest that has accrued on the portion of the outstanding daily loan balance attributable to an income producing purpose. In calculating the portion of the outstanding daily loan balance attributable to an income producing purpose, any repayment of principal is applied proportionately against the outstanding balance of amounts applied to income producing and non-income producing purposes respectively, at the time the repayment is made. However, there are two exceptions.

First Exception - Borrowed money recouped and repaid...

Second Exception - Refinancing mixed purpose debt

18. A taxpayer may choose to refinance a debt outstanding on a mixed purpose sub-account by borrowing an equivalent amount under two separate accounts or sub-accounts. If the sums borrowed under those two separate accounts are equivalent to the respective income producing and non-income producing parts of the existing outstanding debt, we accept that interest accrued on the debt incurred in refinancing the income producing portion of the mixed purpose debt will be deductible.

And further:

44. The balance outstanding on a mixed purpose line of credit sub-account or a mixed purpose loan account is an undivided single debt owed by the borrower to the lender. When repayments of principal are made, it is not considered possible to direct those payments to only that part of the borrowed funds used for a particular purpose as if it were a separate debt. While it may be possible to trace the uses to which different parts of the borrowed funds are put, it is considered repayments of principal need to be applied proportionately to reduce the balance of the outstanding principal attributable to income producing use and non-income producing use respectively, e.g., if 70% of an outstanding line of credit sub-account debt is used for income producing purposes, 70% of any repayment would be in respect of that part of the outstanding debt. However, there are two exceptions. ...

47. The sole purpose of the borrowing used to refinance money used at that time for income producing purposes is to continue to have the use of those funds for income producing purposes. Similarly, the sole purpose of the borrowing used to refinance money used at that time for non-income producing purposes is to continue to have the use of those funds for non-income producing purposes. Therefore, we accept that interest accrued on the debt incurred in refinancing the income related portion of the previous mixed purpose debt will be deductible.

TR 2000/2 recognises but does not accept the alternative view and says:

50. It has been further suggested that the taxpayer can allocate a repayment to that portion of borrowed moneys used for a particular purpose. The decision in FC of T v. Carberry 88 ATC 5005; (1988) 20 ATR 151 is cited in support of this view. ...

51. The decision in Carberry is relevant to establishing the original use of the borrowed funds. On the facts of that case it was open to the tribunal to conclude that the whole of the borrowed funds were applied to an income producing use. In reaching this conclusion, the Tribunal did not apply a strict tracing approach to the borrowed funds. However, as recognised by Davies J in that case on appeal to the Federal Court, an apportionment of interest would have been required if the Tribunal had found as a matter of fact that the borrowed funds had been applied to both income producing and private purposes.

52. The decision in Carberry is not inconsistent with the basis of apportionment outlined in this ruling in relation to cases involving borrowed funds applied to both income producing and non-income producing purposes.

That is, the Commissioner does not allow repayments to be directed to one notional portion of a dual purpose loan. As is noted above however, it is recognised that where a loan is legitimately refinanced, as outlined above, and the sole purpose of the relevant borrowing becomes income-producing, the interest would be fully deductible. The most recent discussion of this area is found in Re Domjan and FC of T [2004] AATA 815 where the AAT accepts the Commissioner's view in TR 2000/2 in this regard (see especially paragraph 56).

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