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Edited version of your private ruling
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Ruling
Subject: Interest on loan taken out to comply with court order
Question 1
Are you entitled to claim the interest expenses on a loan taken out in order to pay out your spouse to comply with a court order?
Answer: No
Question 2
Will additional borrowing taken out in order to pay out your spouse affect the cost base of your rental property?
Answer: No
This ruling applies for the following period
Year ended 30 June 2013
The scheme commenced on
1 July 2012
Relevant facts and circumstances
Whilst you were married you purchased an investment property solely in your name.
You are currently negotiating a financial settlement with your spouse as you have separated.
There is an outstanding mortgage on the property.
There has been a court Financial Settlement, and in a 50/50 split of assets, your spouse is entitled to an amount in relation to this property.
As a way of keeping the property you wish to borrow the funds from the bank to pay your spouse.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 110-25.
Reasons for decision
Loan interest expense
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 earning of exempt income.
The general principles relevant to the deductibility of interest expense are set out in Taxation Ruling TR 95/25. The test is one of characterisation and the essential character of an expense is a question of fact to be determined by reference to all the circumstances.
Where a loan is taken out, the use test is applied to determine the deductibility of the interest. This is the basic test of deductibility of interest and looks to the application of the borrowed funds as the main criteria. This 'use' test was established in FC of T v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339.
Essentially, it is the use to which the borrowed funds are put that will determine the deductibility of the interest. If the borrowed funds are used to produce assessable income, then the interest will be deductible. If the funds are used for non-income producing purposes, then the interest will not be deductible.
In your case, your new loan will be used to pay your spouse the amount owed to them.
The payment to your spouse is considered to be private in nature as it eventuated as a result of family law proceedings. Any interest incurred on this loan is therefore not deductible.
Consequently, you are not entitled to claim a deduction for the interest incurred on the loan raised to pay your spouse in order to comply with the court settlement.
Cost base of the property
In your situation you already own the rental property and any borrowings made to pay to your spouse as part of your financial settlement will not effect the cost base of your rental property.
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