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Ruling
Subject: Deductibility of interest
Question:
Can the partnership claim a deduction for interest incurred on a loan from a related family trust used to refinance a loan to purchase a commercial rental property where the interest charged is at commercial rates?
Answer:
Yes.
This ruling applies for the following period
Year ending 30 June 2013
The scheme commenced on
1 July 2012
Relevant facts
A related party borrowed funds from a bank with a fixed term. The borrowing was for a business operated by that party.
The business was sold prior to the expiry of the loan term with a remaining loan amount outstanding.
The bank will charge a fee to payout the loan before the expiry.
The partnership has a loan that was used to purchase a commercial rental property that is providing a rental return.
The partnership will refinance that loan using funds borrowed from the related party and pay interest to them at a commercial rate.
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.
Taxation Ruling TR 95/25 considers the deductibility of interest. 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. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed moneys is considered to be incurred in gaining or producing assessable income.
Refinancing of a loan does not break the nexus between outgoings of interest under the loan and the income earning activities.
In your case, the partnership has a loan that was used to purchase a commercial rental property that is providing a rental return. The partnership will refinance that loan using the funds from the related party and pay interest to them at a commercial rate.
The interest incurred on the loan from the related party will be deductible under section 8-1 of the ITAA 1997 where the funds are used for an income producing purpose.
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