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Ruling

Subject: Interest - investment property

Questions and answers

This ruling applies for the following periods

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commenced on

1 July 2011

Relevant facts

You and your spouse purchased an investment property in an earlier income year, and you and your spouse borrowed $ to do so.

The $ was used entirely to purchase the investment property, stamp duty and improvements.

You and your spouse are the owners on the title of the property.

You sold the investment property and there was a shortfall so you were unable to fully clear the borrowings taken out to originally finance the purchase of the property. Also as this property had a fixed term mortgage on it, you would have had incurred 'break out fees' of $ to finalise the mortgage ahead of the fixed term.

You did not pay off any of the mortgage on the investment property with the sale proceeds as you would still incur break out fees (which you could not afford to pay).

All of the proceeds from the sale of the investment property were used to pay off your personal residence mortgage and your personal residence was used as security for the investment property loan up until the personal residence property was sold.

When you sold your personal residence a few months later, you transferred the security to cash held in an investment account. This investment account is interest bearing. Again you did not pay out some or all of the investment property loan as you could not afford the break out fees.

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 earnings of exempt income.

Consequently interest expenses incurred in the course of producing assessable income are generally deductible.

Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities states that a loss or outgoing can be deductible even if it is incurred after the cessation of income producing activities. However, in order to be deductible the occasion of the outgoing must be found in those income earning activities.

Taxation Ruling TR 2004/4 states further that if the loan continues for reasons not associated with the former income earning activities, or where there has been a conscious decision to extend the loan for a purpose which is unrelated to the original reason as to why the debt was incurred, then the nexus between the outgoings of interest and the relevant income earning activities will be broken.

In this case the loan was taken out to purchase an investment property. Following the sale of the property there were insufficient funds to fully discharge the loan and you could not afford to pay 'break out' fees to end the loan as it was fixed term, so interest continued to be incurred.

You used the funds from the sale of the investment property to pay out the mortgage on your personal residence. As your personal residence is not an income producing asset, the borrowed funds were no longer being used for an income earning activity and so the nexus between the outgoings of interest and an income earning activity was broken. Accordingly, the interest expense incurred on your investment loan after the funds were used to pay off your personal residence mortgage will not be deductible.

Taxation ruling TR 95/33 Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings makes the point that if the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure to determine whether the outgoing is wholly deductible. This may, depending on the circumstances of the particular case, include an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing. If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective other than producing assessable income, then the outgoing must be apportioned between the pursuit of assessable income and the other objective.

In this case, after the sale of your personal residence, the funds were deposited into an interest bearing investment account. As these funds were only deposited into an investment account to act as security on your investment loan and could not reasonably be expected to pay interest at a rate exceeding the rate you are paying on your loan, it is considered that the outgoing of interest expense needs to be apportioned and so will be allowed only to the extent (dollar amount) of your related interest income. Accordingly, the interest incurred on your investment loan is partially deductible under section 8-1 of the ITAA 1997.

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