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This edited version has been archived due to the length of time since original publication.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.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of private ruling

Authorisation Number: 1011826188962

Ruling

Subject: Reverse mortgage loan - interest

Question 1

Are you entitled to a full deduction for interest incurred on a reverse mortgage loan where the funds are used for investment purposes?

Answer: No.

Question 2

Are you entitled to a partial deduction for interest incurred on a reverse mortgage loan where the funds are used for investment purposes?

Answer: Yes (as identified below).

This ruling applies for the following periods

Year ended 30 June 2010

Year ending 30 June 2011

The scheme commenced on

1 July 2005

Relevant facts

You and your spouse accepted an offer to enter into a loan contract with a credit provider.

The credit provider appointed a mortgage manager to manage your loan contract and the securities.

The loan type offered was a reverse mortgage loan; the borrowing is secured by your primary residence.

You must make one repayment on whichever of the following happens first:

Your spouse has since passed away.

The borrowing is fixed for 10 years, when the fixed rate term expires the loan will default to the residential variable rate. The full amount of funds was invested in order to fund your retirement.

The interest is calculated daily and charged to your borrowing on the first business day of the month, and you receive half yearly loan statements.

Your investment failed and you have received a partial return of capital.

You have reinvested the return of capital into shares that provide dividend income. A portion of these funds were subsequently used for private purposes.

Relevant legislative provisions

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, or relate to the earning of exempt income.

Whether interest has been incurred in the course of producing assessable income generally depends on the purpose or 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 generally considered to be incurred in the course of producing assessable income: Taxation Ruling TR 95/25.

In your case all of the funds borrowed have been used to derive assessable income, up until the point shares were sold and the proceeds used to purchase a private use item. To determine the extent of which interest remains income related after the sale of the shares to purchase a personal use item, interest after this time would need to be reduced by multiplying it against the following figure:

However, your entitlement to an interest deduction is further limited for reasons noted below.

The High Court in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher's Case) considered the circumstances where the interest outgoings of a taxpayer exceeded the assessable income relevant to this expense. It was found that where the assessable income derived from an arrangement is less than the relevant outgoings and the facts lead to the conclusion that there is another objective for incurring the expense, only part of the outgoing is an allowable deduction. The court found it was fair and reasonable to limit the deduction of the amount of income actually received.

In your situation, you have received a return of capital and invested the funds into the purchase of shares that provide dividend income. You are currently incurring an interest expenses on the invested funds. Your circumstances are consistent with those examined in Fletcher's Case as the amount of interest incurred on the borrowing will exceed the amount of assessable income derived from the share, indeed this disparity will increase with the compounding of the borrowing under the reverse mortgage. As it is clear the arrangement is not commercially viable, it is reasonable to conclude an objective other than the single pursuit of earning assessable income exists.

Therefore, after reducing your interest to take into account the purchase of the personal use item (see above) the remaining interest is only deductible to the extent of the dividend income received from the shares purchased with the reinvested funds. For the year ended 30 June 2010, this means you can only claim the equivalent of the amount of related dividend income you derived.

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