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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of private ruling

Authorisation Number: 1011642421659

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Ruling

Subject: Interest deduction

Question

Will you be entitled to a deduction for interest from funds borrowed from an overseas bank to purchase an investment property overseas?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2011

The scheme commences on:

1 July 2010

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 are an Australian resident for taxation purposes.

You intend to purchase an investment property overseas and it will be used for income producing purposes.

You will borrow the money from an overseas bank.

You will incur interest expenses in relation to the loan from the overseas bank for the investment property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 26-25

Income Tax Assessment Act 1997 Section 960-100

Taxation Administration Act 1953 Section 12-245 of Schedule 1

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.

Deductibility of interest

Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income.

 

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. The 'use' test, established in the Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Where borrowed funds are used to purchase a property, the interest will be deductible to the extent that the property is used to produce assessable income.

Generally, an Australian resident can claim a deduction for interest expenses incurred on funds borrowed to purchase a property overseas if the property is used for income producing purposes.

However section 26-25 of the ITAA 1997 specifies that interest is not deductible if the withholding tax requirements have not been met.

Withholding tax

Section 12-245 of Schedule 1 of the Taxation Administration Act 1953 (TAA) provides that an entity must withhold an amount from interest that it pays to another entity if the recipient has an address outside Australia. The rate of tax on interest income, as specified in Regulation 41 of the Taxation Administration Regulations 1976, is 10%.

According to section 960-100 of the ITAA 1997, entity means any of the following:

As you will be making a payment to a non-resident entity overseas you will be required to deduct and remit the 10% non-resident withholding tax on the payment of interest. If you comply with the withholding requirement, the interest expense that you incur will be deductible under section 8-1 of the ITAA 1997, as the interest expense would have been incurred in producing your assessable income.

Note

The 10% non-resident withholding tax is not a tax on your income; rather it is a tax payable on the interest income earned by a non-resident (in this case, the overseas bank) from sources in Australia. However, you will be required to deduct the 10% non-resident withholding tax from the interest payment you will make to the non-resident and remit the amount deducted to the Australian Taxation Office (ATO). For example, if you incur an interest expense of $1,000 in relation to your overseas rental property, you would be required to deduct and remit $100 to the ATO, leaving $900 to be paid to the overseas bank. You may wish to contact your overseas bank to discuss this matter with them.

You must be registered for pay as you go (PAYG) withholding before you withhold tax from interest, dividend or royalty payments to non-residents. If you are not already registered, you can register:

Fact sheet: PAYG withholding from interest, dividends and royalties to non-residents was sent to taxpayer.

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