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Edited version of your written advice

Authorisation Number: 1012698729258

Ruling

Subject: Prepaid interest

Question

Are you entitled to a deduction for prepaid interest on an investment property loan in the 2013-14 financial year?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

You jointly own an investment property

You signed an authority in the 2013-14 financial year with the bank to prepay the annual interest on the property in 2014.

The amount was not deducted from your account until the 2014-15 financial year.

Your bank has written to you and acknowledged that they held the authority, however, it was overlooked and the interest not paid from your account by the due date.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1936 Section 82KZM

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.

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. Where a borrowing is used to acquire an income producing asset, the interest on this borrowing is considered to be incurred in the course of producing assessable income.

In your case, you utilised the loan funds to purchase an investment property. Therefore the loan interest is an allowable deduction.

However as you are also prepaying the interest expense the application of section 82KZM of the Income Tax Assessment Act 1936 (ITAA 1936) must be considered.

The effect of section 82KZM of the ITAA 1936 is to evenly spread the deduction for prepaid interest over the years comprising an 'eligible service period'. The 'eligible service period' is the period to which the interest relates, not the term of the loan, being a period not exceeding 10 years (subsection 82KZL(1) of the ITAA 1936).

A prepaid expense will not be subject to these timing rules where the following factors exist:

You are an individual who is not carrying on a business. The interest expense would be deductible under section 8-1 of the ITAA 1997 and the 'eligible service period' is 12 months. Accordingly, the interest is not subject to the timing rules in section 82KZM of the ITAA 1936 and is deductible in the year in which it is incurred.

When was the expense incurred?

Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions, provides guidance on when an expense is incurred. There is no statutory definition of the term 'incurred'; however, the ruling outlines general rules, settled by case law, which will assist in most cases in defining when an outgoing is incurred.

Broadly, an expense is incurred at the time that a present money debt is owed and cannot be escaped. Importantly, a taxpayer need not have actually paid any money to have incurred such an outgoing, providing they are definitively committed to it in the year of income. That is, an expense may be incurred where there is a presently existing liability to pay a pecuniary sum.

In your case, you had a presently existing liability when you signed the agreement with the bank to prepay the interest in 2014. You were definitely committed to the outgoing in the 2013-14 financial year and it was only due to an error on the banks part that the relevant entries were not made until the 2014-15 financial year.

Therefore, the interest expense was incurred in the 2013-14 financial year. As such you are entitled to claim a deduction for the prepaid interest in the 2013-14 financial year.

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