Edited version of private ruling

Authorisation Number: 1011567596853

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Ruling

Subject: Interest expenses

1. Are you entitled to a deduction for interest expenses on both your investment loans held jointly with your spouse for your rental property whilst you undertake extensions?

Yes.

2. Are you entitled to a deduction for interest paid on the shortfall loans in your spouse's name for your rental property?

No.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You own a rental property that you have been renting for a number of years.

You intend to add a second floor to the building to increase the value of the property and increase the rental income.

You lodged a development application and received approval from the council.

You were assured by the builder that the documentation and building would be no more than three to four months to complete to allow you to re-rent.

The property has not been rented for part of the year since your tenants at the time vacated the property on establishing your intentions.

You applied for a construction certificate from the council and you have been waiting for approval. You have recently been advised by telephone the construction certificate has been granted.

Due to these delays you have lost your builder which you booked 12 months in advance and you now intend to proceed as an owner builder. The work will be carried out with family resources and may take up to one year from the date of final approval from the council to complete.

You have confirmed that the property will be re-rented on completion of the extensions.

When purchasing the property you obtained a loan jointly with your spouse and two other loans in your spouse's name to cover a shortfall. Your spouse became a guarantor in order for the bank to provide the required funds to purchase the property in your name only.

You have obtained a separate loan in joint names with your spouse to complete the extensions as you could not refinance your main loan as it has a fixed interest rate and would be costly to refinance.

All payments to the main loan and additional loan including interest are paid by you only.

You have a verbal agreement with your spouse for the shortfall loans in his name where all payments are made by your spouse including interest. You do not have any arrangements in place for you to pay your spouse for the payments and interest expenses incurred for the shortfall loans.

Reasons for decision

Summary

You are entitled to a deduction for interest expenses incurred on your main loan and new investment loan held jointly with your spouse whilst you undertake extensions to your rental property.

However, you are not entitled to a deduction for interest expenses on shortfall loans in your spouse's name.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a deduction is allowable for expenses incurred in gaining assessable income, provided those expenses are not capital, private or domestic in nature.

Interest on funds used to purchase a property on which the taxpayer intends to build an income producing asset may be deductible from the time of the acquisition of the property (Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steels case)) under section 8-1 of the ITAA 1997. It is not necessary to show that the interest was incurred in producing income of a particular year. Interest that is otherwise deductible is not excluded from deductibility simply because no assessable income was derived in the relevant year.

The Commissioner limits the operation of Steele's case to circumstances where:

· the interest is not preliminary to the income- earning activities. In other words, it is not incurred too soon

· the interest is not of a private or domestic nature

· the period prior to the derivation of income is not too long that the required connection between the outgoing and income is lost

· the interest is incurred with one end in view, namely the gaining or producing of assessable income, and

· continuing efforts are undertaken in pursuit of that end.

While this does not require constant on-site development activity, the requirement is not satisfied if the venture becomes truly dormant and the holding of the asset is passive, even if there is an intention to revive the venture at some time in the future

Your rental property has been income producing. You are in the process of adding a second floor to the building. You have received a development approval from your council but due to delays you expect that the extensions may take up to one year from the time of council approval. Once completed, the property will be re-rented.

In these circumstances, it is considered that the interest expenses are not incurred at a point too soon. The length of time between when your rental income ceased and the completion of construction of your extensions is not considered to be too long that the necessary connection between the interest outgoings and the assessable income is lost. There is no private or domestic purpose in your activity. Continuing efforts are being undertaken to have the property available for re-renting.

You have the following loans for the property:

· main investment loan held jointly with your spouse

· new investment loan for the extensions held jointly with your spouse, and

· two shortfall loans in your spouse's name of which he pays the interest.

Loans in joint names

You and your spouse have a verbal agreement where you pay all costs including repayments and interest on the loans held in joint names. In addition, the loans held in joint names are for cosmetic rather than legal purposes.

Accordingly, you are entitled to a deduction under section 8-1 of the ITAA 1997 for interest expenses incurred during the time of construction of the second floor of your rental property for your main loan and new investment loan held jointly with your spouse.

Loans in name of spouse

However, your spouse has freely made available shortfall loans for the purchase of your property and makes all the loan payments and interest expenses to these loans. You do not have an agreement to make payments to your spouse for interest expenses for these loans.

Accordingly, as you have not incurred any interest expenses for these loans, you are not entitled to a deduction for interest expenses on the shortfall loans in your spouse's name.

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