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Ruling
Subject: Interest expenses
Question 1
Are you entitled to a deduction for interest expenses on a rental property after the property is no longer available for rent?
Answer
No.
Question 2
Are you entitled to a deduction for interest expenses incurred on redrawn funds used to repay your margin loan?
Answer
Yes.
This ruling applies for the following periods:
Year ended 30 June 2014
Year ended 30 June 2015
The scheme commenced on
1 July 2013
Relevant facts
You have a margin loan that is used to acquire shares.
You also have a home investment loan that was used to acquire a rental property. The property has been rented and used for income producing purposes.
The home investment loan has an associated offset account, which is used to offset some of the interest expense incurred on that loan.
You intend to redevelop the investment property, after which you will most likely use it as your main residence.
The redevelopment works are not due to any damage from the tenants.
You intend to use some of the cash in the offset account to repay the home investment loan.
You intend to redraw funds from the home loan account to repay part of the margin loan.
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.
A number of significant court decisions have determined that for an expense to be an allowable deduction:
· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478 (Lunney's case)),
· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and
· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).
Generally a deduction is allowable for expenses incurred for the period a rental property is rented or is available for rent.
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.
In your case, while the property is rented, a deduction for the associated interest expenses is allowable. However, after the tenants move out and the property is no longer available for rent, no deduction is allowable. That is, as the property is not available for rent during the redevelopment, no deduction is available during this period. The nexus between your interest expenses and any prior assessable rental income is not sufficient. Therefore no deduction is allowable under section 8-1 of the ITAA 1997.
Redrawn funds
Taxation Ruling TR 2000/2 considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities.
The ruling establishes drawing any excess or available funds from the loan is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put.
Where a person uses the redrawn funds for different purposes then the loan account becomes a mixed purpose account. In a mixed purpose loan, the interest must be apportioned between the income producing and non-income producing purposes. The part of the accrued interest attributable to the funds used for private purposes is not deductible.
In your case, where you redraw funds from your home loan account, we need to consider the use of these funds.
Interest on a new loan used to repay an existing investment loan will generally be deductible as the character of the new loan is derived from the original borrowing.
Therefore where you use redrawn funds from your home loan to repay your existing margin loan, the interest expenses incurred on these redrawn funds is an allowable deduction. This is because the borrowed funds are being used for income producing purposes.
However if some of the funds from your home loan are also being used for a non-deductible purpose, then the interest expenses need to be apportioned accordingly.
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