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Edited version of private ruling
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Ruling
Subject: interest on redrawn funds
Are you entitled to a deduction for the interest relating to the redraws you have made from your rental loan?
No.
This ruling applies for the following period
Income year ended 30 June 2010
The scheme commenced on
1 July 2009
Relevant facts and circumstances
You own a home you use as your primary residence (your home). You obtained a loan to assist with the purchase of your home (your home loan).
Your home loan also consisted of an additional amount which you intended to use to fund future renovations to your home (your renovation funds). This amount was drawn as part of the original borrowing and you intended to place these additional funds into an account offset against your home loan until you were required to pay for the renovations.
You own a rental property. You have a loan which relates to this rental property (your rental loan). This loan has a redraw facility, which allows you to withdraw surplus funds from the loan.
Upon advice from your lender, you decided to deposit your renovation funds directly to your home loan in lieu of the offset account.
You deposited the renovation funds to your rental loan instead of your home loan as you mistook one loan for the other as the balances were the same.
You subsequently redrew the renovation funds from your rental loan in order to pay for the renovations to your home.
You realised your error when your lender contacted you to query your actions. You then redrew the remainder of your renovation funds from your rental loan in an attempt to correct your error and reinstate the loan to its original borrowing amount.
You are requesting the Commissioner exercise a discretion to continue to deduct the whole of the interest incurred on the rental loan as an expense relating to your rental property.
Relevant legislative provision
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Section 8-1 of the Income Tax Assessment Act 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.
Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. Interest incurred on a loan relating to a rental property will generally be deductible.
Taxation Ruling TR 2000/2 examines the treatment and consequences of payments to loans in excess of the required amount and the subsequent redrawing of these funds.
It is considered that a repayment to a loan account in excess of the required amount is a permanent reduction to this debt. Repayments of an amount to a loan do not create a debt due to the borrower, but simply allows the borrower to then draw funds from the loan to an agreed limit. These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant.
Redraws may then result in circumstances where a loan contains mixed purposes. In these instances you are entitled to a deduction for the portion of the interest of the loan which relates to an income producing purpose. Apportionment of the interest between the mixed purposes may be required. Paragraphs 19-20 of TR 2000/2 contain formulas which can be used to calculate the income producing portion of interest.
In Domjan v. FC of T 2004 ATC 2204; (2004) 56 ATR 1235, the AAT confirmed the view taken by the Commissioner in TR 2000/2. In this case, the taxpayer repaid money into their investment loan account and then used the funds available in the redraw facility to pay for various personal and investment expenses. The question to be answered by the tribunal was whether the whole of the interest incurred on the loan was a deductible expense.
The taxpayer argued that the loan was 'a chose in action with a right to access funds in the redraw facility as if it was a separate sub-account in the loan facility'. The taxpayer further argued they were merely re-accessing private funds when they redrew and that the loan was still only attributable to their investment activities, making the interest deductible. However, the Tribunal rejected this argument.
It agreed with the Commissioner that in the taxpayer's case:
The extra repayments…create a debt due by the lender to the borrower and are…an asset of the borrower after they have been used to discharge part of the loan debt… [T]he reduced loan balance … [comprises] the previous loan balance with notional offset credit available in respect of extra repayments as if those extra repayments were standing to the credit of the borrower in a separate loan account in the books of the lender.
The Tribunal further agreed that amounts redrawn from this type of loan facility constituted the new borrowing of funds and that consequently, the interest payable on the amounts redrawn for private use was not deductible.
In your situation, depositing the renovation funds to your rental loan is considered a permanent reduction to the loan. The nature of the redraws you have made are characterised by the use to which they have been put, that is, to fund the renovations to your home. Accordingly the interest relating to these redrawn amounts is of a private nature and is not deductible.
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