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Edited version of your private ruling
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Ruling
Subject: Interest expenses
Question:
Are you entitled to a deduction for the interest expenses incurred?
Answer:
No.
This ruling applies for the following periods:
Year ended 30 June 2011
Year ended 30 June 2012
The scheme commences on:
1 July 2010
Relevant facts and circumstances
You and your spouse decided to buy an investment property.
You had paid out the mortgage on your primary place of residence and used this property as security to take out a new loan for the investment property.
You subsequently decided to move into the investment property and rent out your original house. As a result, your original house has become your investment property and you live in the new house you recently purchased.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
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, or relate to the earning of exempt income.
Taxation Ruling TR 95/25 deals with the general principles governing deductibility of interest under section 8-1 of the ITAA 1997.
To establish that there is a sufficient connection between incurring an interest expense and the gaining or producing of assessable income, regard must be given to all the circumstances including the use to which the borrowed funds are put.
The 'use' test, established in FC of T v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks to the application of the borrowed funds as the main criteria. Where borrowed funds are used for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income.
The 'use' test was relied upon by the Board in its decision of Case B11, 70 ATC 46 (Case B11). In that case, the taxpayer purchased a new home with borrowed money, having decided to retain ownership of his former home with a view to leasing it. The former home was let to a tenant for a term commencing at about the same time that the taxpayer vacated it and took up residence in his new home. The taxpayer's claim for a deduction against the rent received for the interest paid on the borrowed money was disallowed. It was held that the borrowed money not only enabled the taxpayer to retain his former home for income-producing purposes but also to acquire ownership of a new house as a family residence. Although it would not have been possible to achieve both these results without borrowing, no apportionment of the interest paid is possible as the deductibility of interest depends directly and only on the use to which the principal is put.
In your case, you decided to purchase an investment property. You subsequently moved into the new property and rented out the house you had been living in. Your case can be compared to that of Case B11 in that the use of the money raised from the equity in your previous residence was used for the purpose of purchasing a new primary residence which is of a private purpose and not an income-producing purpose.
Accordingly, as the borrowed funds were used to purchase your new primary residence and will not be used for income-producing purposes, you are not entitled to a deduction for the interest expenses you incurred.
Note
Although you are not entitled to a deduction for the interest incurred, this does not preclude your entitlement to a deduction for other expenses (for example, repairs, rates and insurance) incurred for your investment property.
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