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Ruling

Subject: Deduction-interest

Questions

Are you entitled to a deduction for all the interest you incur on the new loan which relates to your rental property, once the property is rented or available for rent?

Answer: No

Are you entitled to a deduction for a portion of interest expense you incur on the new loan which relates to your interest in the rental property and excluding all private redraws, once the property is rented or available for rent?

Answer: Yes

This ruling applies for the following periods:

Year ended 30 June 2011

The scheme commenced on:

1 July 2010

Relevant facts

You borrowed funds from a financial institution to purchase a block of land and to build a dwelling on the block of land.

The loan (loan one) is in your name.

You used the property as your main residence.

You redrew fund from the loan one and used the funds for other private purposes.

You married.

You refinanced the outstanding debt on loan one.

You and your spouse borrowed funds to payout the outstanding debt on loan one and also additional funds which were used for private purposes.

Loan two is in you and your spouse names.

You transferred the title of the property to joint names.

The property was made available for rent.

You and your spouse have made additional repayments to loan two and have also redrawn additional funds which have been used for private purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1.

Reasons for Decision

Interest deduction

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 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. The character of a new loan which refinances a previous loan follows from that previous loan: Taxation Ruling TR 95/25.

Where two taxpayers borrow jointly, both taxpayers will have presently existing pecuniary liability to discharge interest on that borrowing once it accrues and is due and payable: paragraph 6 of Taxation Ruling TR 97/7. Therefore, each of the borrowers will only incur their share of the interest expense, notwithstanding circumstances where one borrower may meet all repayments in respect of the borrowing: paragraph 6 of Taxation Ruling TR 97/7.

Redraws can create a mixed purpose loan

There are a number of loan arrangements under which a borrower may redraw previous repayments of the loan principal. The redraw facility allows the borrower to make payments over and above the minimum payments required under the loan agreement, and then permits the borrower to redraw an amount equivalent to those payments in excess of interest, fees and charges at a later time.  The payments in excess of interest, fees and charges reduce the borrower's outstanding loan debt and interest and money redrawn increases the outstanding loan debt.

Taxation Ruling TR 2000/2 discusses the deductibility of interest on drawings against a line of credit or redraw facility.

Apportionment of interest for mixed purpose loans

Where a loan contains mixed purposes, you are entitled to a deduction for the portion of the interest on a loan which relates to an income producing purpose. Therefore apportionment of the interest is required. Apportionment must be made on a fair and reasonable basis. The method provided in TR 2000/2 is not the only method that may be used. The onus is on the taxpayer to show that the method they have used is fair and reasonable in their circumstances. 

Taxation Ruling TR 2000/2 provides information which can be used as a guide in relation to the calculation of the apportionment of interest on line of credit facilities (paragraphs 19 to 21, TR 2000/2).

Repayment of a mixed purpose loan

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. For example, if 96% of an outstanding line of credit debt is used for income producing purposes, 96% of any repayment would be in respect of that part of the outstanding debt

We acknowledge your efforts in making additional repayment to the new loan. However, the Commissioner has no discretion to treat the repayments as separate amounts that can be redraw at a later time, not affecting the loan balance. The new loan is treated as undivided single debt owed by you and your spouse to the lender. The deductibility of the interest expenses incurred in relation further redraws will depend on what the funds are used for.

In your circumstances, redraws you have made under the new loan have been used for private purposes. The further redraws are considered new transactions and the new loan is a mixed purpose loan. Therefore you need to apportion the interest expenses between the income producing purposes and the non-income producing purposes in accordance with new account.

It is accepted that a portion of the loan is referable to your interest in the property. However, this portion has been reduced upon the refinance of the original borrowing into joint names and the repayment and subsequent redraw of monies on both the original and new loans.

Therefore, you are entitled to claim a deduction for your share of the interest expenses incurred on the loan referable to your interest in the property, upon the property becoming available for rent. That is, the interest referable to your share of the loan for the purchase and construction of the property, apportioned to remove the non-income producing purposes as noted above.

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