Edited version of your private ruling

Authorisation Number: 1012552068634

Ruling

Subject: Deduction for interest expense

Question

Are you entitled to claim a deduction for the interest expense?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You borrowed funds to spend on a private project.

A portion of the borrowed funds remained unspent and you placed it in a separate high interest bank account. This account is separate from your two savings accounts.

The money has subsequently been spent on the private project.

While in your bank account this money accumulated interest income for you.

Also at the same time you are paying interest charges for this money and the money already spent on your house rebuild.

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) states:

You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income; or

(d) a provision of the Act prevents you from deducting it.

Interest expenses may be claimed under this section.

The following general principles are relevant to the question of whether interest is deductible under section 8-1 of the ITAA 1997:

The interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be of a capital, private or domestic nature.

The test is one of characterisation and the essential character of an expense is a question fact to be determined by reference to all the circumstances.

The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower.

However, regard must be had to all the circumstances, including the character of the taxpayer's undertaking or business, the objective purpose of the borrowing, and the nature of the transaction or series of transactions of which the borrowing of funds is an element. In some cases, the taxpayer's subjective purpose, intention or motive may also be relevant.

Taxation Ruling TR 95/33 "Income tax: subsection 51(1) relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings" is relevant. (Note: subsection51(1) has been replaced by section 8-1 of Income Tax Assessment Act 1997)

TR 95/33 considers the decision of the Full High Court of Australia in Fletcher & Ors v FC of T 91 ATC 4950; (1991) 22 ATR 613 (Fletcher case) and in particular, considers situations in which a taxpayer's subjective purpose, motive or intention is relevant in determining the availability of an income tax deduction under section 8-1 of the ITAA 1997.

The ruling states that if it is concluded that the disproportion between the outgoing and the assessable income is essentially to be explained by reference to the independent pursuit of some other objective (eg. the obtaining of a tax deduction), then the outgoing must be apportioned between the pursuit of assessable income and the other objective.

In certain circumstances, the subjective purpose, intention or motive of the taxpayer can be relevant in determining whether the outgoing has the necessary connection with the carrying on of the taxpayer's business or earning of assessable income.

Where there is no obvious commercial connection between the loss or outgoing and the production of assessable income, or where the expenditure did not achieve its intended result, it may be necessary to have regard to the taxpayer's subjective purpose, motive or intention. These factors may be relevant in determining whether the expenditure has actually been incurred for the purpose of gaining or producing assessable income.

When considering the subjective purpose, motive or intention in incurring a loss or outgoing, regard must be had to the purpose or motive that the taxpayer had in mind when the loss or outgoing was incurred.

In your case, you borrowed money with the intention of spending it for private purposes A portion of the borrowed money was not spent at the time and was placed in a bank account for you to spend at a later date, which you did. The earning of your interest income was a consequence of holding the money in a bank account and not the motive behind borrowing the money.

Conclusion

The dominant purpose for incurring the expense was of a private and domestic nature and therefore would not normally be deductable.

Your interest was earned as a consequence of you undertaking this private activity. However, you sought to maximise the interest earned by using a high interest account and you also retained it separate from your everyday accounts so that it could be spent on the original intended purpose.

The interest expense was incurred in gaining or producing assessable income. Therefore, a deduction is allowable for interest on the additional monies borrowed.

TR 95/33 allows for an apportionment of the loss or outgoing that is fair and reasonable in the circumstances.

In the Fletcher case, which involved a taxpayer in gaining or producing the assessable income, it was considered 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year.

You are entitled to a deduction for the interest expense incurred to an amount not more that the interest earned on the corresponding funds held in your high interest account.

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