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Ruling

Subject: Interest expenses

Question 1

Where all the money deposited into an offset account is used for private purposes, are you entitled to a deduction for the interest expense incurred on the gross principle amount of your loan once the property is used for income producing purposes?

Answer

Yes.

Question 2

Where money is later deposited into an offset account, are you only entitled to a deduction for the interest expense incurred on the net amount of your loan where the property is used for income producing purposes?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commenced on

1 July 2011

Relevant facts

You have purchased a house in joint names which is your main residence.

Two of the loans used to purchase the house have offset accounts where interest is paid on the net debt on the loan.

You place spare cash into the offset accounts to reduce the interest payable. The loan balance has not been reduced.

You intend to use the funds in the offset account to purchase a new house.

You intend to then rent out your current house.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Interest expenses 

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.

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. However, where a loan relates to a private purpose, no deduction is allowed.

When a person moves out of their home and then rents out the property at a commercial rate, the interest on the outstanding loan is generally an allowable deduction.

Mortgage offset account

Taxation Ruling TR 93/6 outlines the Commissioner's view on loan account offset arrangements which are used to reduce the interest payable on a taxpayer's loan account. TR 93/6 provides that an acceptable loan account offset arrangement with dual accounts operates as follows:   

· There are two accounts - a loan account and a deposit account. It is accepted that where the deposit account is a sub-account, it will be treated as a separate account.

· No interest is received on the deposit account.

· The reduction of the loan account interest should be achieved by offsetting the balances of the two accounts.

A person with an acceptable loan account offset arrangement with dual accounts is entitled to claim a deduction for the reduced amount of interest incurred on the loan account whilst the loan is used wholly for income producing purposes.

This will remain the case even if funds are withdrawn from the deposit account and used for non-income producing purposes. Depositing funds into the deposit account will decrease the interest payable on the loan account but will not decrease the balance of the loan account. Withdrawing funds from the deposit account will increase the interest payable on the loan account but will not increase the balance of the loan account.

In your case, you have a loan offset arrangement that is regarded as an acceptable loan account offset arrangement. Your loan accounts will operate in conjunction with your deposit accounts. Any credit balance of your deposit account will reduce the interest payable on your loan account.

Consequently where you deposit funds into the deposit account, this does not reduce the principle on your loan. You will be entitled to a deduction for the interest charged on your loan account when your original property is used for income producing purposes. Any funds withdrawn from your offset account for private purposes will not affect the deductibility of the interest on your loan.

That is, the use of funds in your deposit account is not regarded as a redraw or a new loan as outlined in Taxation Ruling TR 2000/2.

Please also note that co-owners of a rental property divide the income and expenses for the rental property in line with their legal interest in the property (Taxation Ruling TR 93/32). Therefore you are only entitled to a deduction of the portion of interest expenses incurred according to your legal ownership in the property.

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