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Ruling

Subject: Deduction-interest

Question 1:

Are you entitled to a deduction for the interest expense on the income producing portion on your investment loan?

Answer:

Yes.

Question 2:

Are you entitled to a deduction for the interest expense on the non-income producing portion on your investment loan which was paid out in error?

Answer:

No.

Question 3:

Are you entitled to a deduction for a portion of the refinancing costs?

Answer:

Yes.

This ruling applies for the following period:

Year ending 30 June 2013

The scheme commenced on:

1 July 2012

Relevant facts

You had taken out an interest only loan to purchase an investment.

You refinanced this loan with funds borrowed from a financial lender.

You also borrowed an additional amount to cover the costs of refinancing the loan.

You discharged your initial loan.

When discharging the initial investment loan you incorrectly advised the financial lender to deposit any surplus funds into your personal bank account.

The financial lender used part of the additional funds borrowed to pay the following:

· the refinancing costs

· repay accrued interest on the initial loan.

The balance of additional funds borrowed was repaid into your personal bank account.

You approached the financial lender to reverse the structure of the loan.

You were advised by the financial lender that reversing the structure of the loan could not be done.

Relevant legislative provisions:

Income Tax Assessment Act 1997 section 8-1.

Income Tax Assessment Act 1997 section 25-25.

Income Tax Assessment Act 1997 subsection 25-25(3).

Income Tax Assessment Act 1997 section 25-30.

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.

Further, interest on a new loan used to repay an existing loan that is used for income producing purposes will generally also be deductible as the character of the new loan is derived from the original borrowing (Taxation Ruling TR 95/25).

Mixed purpose borrowings generally
In examining the use of borrowings, there may be instances where the loan has a mixed purpose. Where there is a mixed purpose, only the interest of the portion of the borrowing which is attributed to an income producing purpose is deductible.

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. An 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).

Application to your circumstances

In your case, you had an interest only loan which was being used for income producing purposes. You refinanced the loan balance and borrowed additional funds to pay for refinancing costs. However, at the time of settlement for discharging the initial loan, the character of the loan became a mixed purpose loan as apart of the funds borrowed were repaid into your private bank account and not used for income producing purposes.

We acknowledge that the financial lender was not able to reverse the structure or split the loan amounts borrowed. The Commissioner can only consider what actually occurred rather than what was intended to occur. The Commissioner has no discretion to ignore the previous transaction. The legislation applies to what in fact happened rather than what may have been in mind at some earlier point in time.

As noted above, you are entitled to a deduction under section 8-1 of the ITAA 1997 for the portion of the interest on the loan which relates to an income producing purpose, that is, the funds that were used repay the existing investment loan, the accrued interest and the refinancing costs in relation to the refinancing of your investment property loan. However, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for the portion of the interest on funds which were not used for income producing purposes.

Therefore, the interest expense on funds borrowed to refinance your initial investment property loan needs to be apportioned between the income producing purposes and the non-income producing purposes.

Costs of obtaining finance
Expenditure incurred in borrowing money are normally a non-deductible capital expense. However, section 25-25 of the ITAA 1997 specifically allows a deduction for certain borrowing expenses.

Borrowing expenses, which may include establishment fees, legal fees, stamp duty on the loan and valuation fees, are deductible to the extent that the borrowed moneys are used or are to be used during that income year for income producing purposes. Where the borrowed money is used partly for the purpose of producing assessable income, subsection 25-25(3) applies. It states: 

· If you use the money only partly for that purpose during the income year, you can deduct the proportion of that maximum amount that is appropriate having regard to the extent that you used the borrowed money for that purpose.

Section 25-25 of the ITAA 1997 also states that where borrowing expenses total more than $100, the deduction must be spread over the period of the loan or five years, whichever is less.

In your case, you are entitled to a deduction for the refinancing costs; however, you will need to apportion your refinancing costs to the extent the money borrowed is used for income producing purposes.

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