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Ruling
Subject: Borrowing expenses
Question
Are you entitled to a deduction for your share of the early repayment fee you incurred for your rental property?
Answer
Yes.
This ruling applies for the following periods:
Year ended 30 June 2013
The scheme commences on:
1 July 2012
Relevant facts and circumstances
You and your spouse bought an investment property as joint tenants.
The property has been rented out continuously since settlement.
The property is rented at market rates.
You have never resided in the property and the property has never been used for residential purposes.
The property was financed with a fixed rate investment home loan.
The loan was refinanced to a lower rate, breaking the then fixed rate period.
You were charged an early repayment fee when you refinanced the loan.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 25-30
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.
Section 25-30 of the ITAA 1997 allows a deduction for expenditure to the extent to which it is incurred in discharging a mortgage that you gave as security for a borrowing used in gaining or producing assessable income.
Taxation Ruling TR 93/7 provides guidance on the deductibility of a penalty interest payment. In the ruling, the term 'penalty interest payment' refers to an amount payable by a borrower under a loan agreement in consideration for a lender agreeing to accept an early repayment of a loan.
Where a borrowing is used to acquire an income producing asset, and a penalty interest payment is made to rid you of a recurring obligation to pay interest on the loan, the penalty interest payment is deductible under section 8-1 of the ITAA 1997.
Where a penalty interest payment is made to effect a discharge of a mortgage which secures such a borrowing, the penalty interest payment is deductible under section 25-30 of the ITAA 1997.
Where a penalty interest payment is made upon the repayment of a borrowing incidental to the disposal of the income producing asset, this payment is not taken into account in calculating any capital gains or losses arising from the disposal.
TR 93/7 provides an example at paragraphs 20 and 21:
20. Two years ago, Peter obtained a loan from a financial institution to purchase a rental property. The loan is for a period of five years, with interest payable at a fixed rate of 15 per cent per annum. Because of falls in prevailing interest rates, Peter can now refinance the property with a loan at a lower rate of interest, say 11 per cent. In order to refinance, Peter pays out the first loan early. Under the loan agreement, he incurs a penalty interest payment calculated on the basis of one month's interest for each year of the loan period remaining.
21. The advantage sought in practical terms by making the penalty payment and repaying the first loan is the future interest savings obtainable from the differential in rates charged on the two loans. The payment is therefore of a revenue character and deductible under subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936). Were the refinancing to involve the discharging of a mortgage securing repayment of the first loan, the payment would also have been deductible under section 67A of the ITAA 1936.
Note: Subsection 51(1) of the ITAA 1936 and section 67A of the ITAA 1936 have been replaced with section 8-1 of the ITAA 1997 and section 25-30 of the ITAA 1997 respectively.
In your case, you refinanced a loan which you used to fund an income producing property prior to the expiry of a fixed interest rate period. You incurred an early repayment fee by cancelling the fixed interest rate period early to enable you to change to a lower fixed interest rate. As you incurred a fee to cancel the fixed interest rate period early to enable you to pay less interest, you are entitled to a deduction for your share of the fee under section 8-1 of the ITAA 1997.
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