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Edited version of your written advice
Authorisation Number: 1012736600172
Ruling
Subject: Rental property interest expenses
Question 1
Are you entitled to claim a deduction for interest incurred on funds borrowed to acquire your spouse's share of a property that will be used for investment purposes?
Answer
Yes
Question 2
Will the provisions of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to deny you a deduction for the interest?
Answer
No
This ruling applies for the following periods
Year of income ended 30 June 2015
Year of income ended 30 June 2016
Year of income ended 30 June 2017
The scheme commences on
1 July 2014
Relevant facts and circumstances
1. You and your spouse jointly own a property (Property 1). This property has been your main residence since its acquisition.
2. You recently entered into a contract to purchase a property (Property 2).
3. You will be the sole owner of Property 2. This property will be used as the main residence of you and your family.
4. After consideration, you have decided to retain Property 1 as a long term investment with a view to earning assessable rental income, rather than to sell it and purchase a new investment property. You acquired your spouse's 50% interest in the property and use the property as a long term rental property.
5. This arrangement is also being entered into for asset protection purposes.
6. You borrowed from a bank, which represents 50% of the current market value of Property 1. After acquisition, you are the sole owner of Property 1.
7. You will use Property 1 as a rental property.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 8-1
Income Tax Assessment Act 1936 Part IVA
Further issues for you to consider
Reasons for decision
Question 1 - deductibility of interest
8. Section 8-1 of the Income Tax Assessment Act 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.
9. 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.
10. 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.
11. 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 generally be deductible.
12. In your case, you intend to take out a commercial loan to enable you to purchase your spouse's share of a property which you will use for investment purposes. Therefore the borrowed funds will be used for income producing purposes (derivation of rental income).
13. Accordingly, you are entitled to a deduction for interest incurred on the loan obtained to purchase a share in a property from which you will be deriving rental income.
Question 2
14. Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances if a taxpayer obtains a tax benefit in connection with a scheme, and it can be concluded that the scheme, or any part it, was entered into for the dominant purpose of enabling a tax benefit to be obtained. Part IVA is a provision of last resort.
15. In order for Part IVA to apply, the following requirements must be satisfied:
• There must be a scheme as defined by section 177A of the ITAA 1936.
• There must be a tax benefit as defined by section 177C of the ITAA 1936, obtained in connection with the scheme
• The scheme must be one to which Part IVA applies, as determined by section 177D of the ITAA 1936, where it would be concluded that the taxpayer (or any other person involved in the scheme) had the sole or dominant purpose of entering into the scheme to obtain the tax benefit.
16. It is determined that Part IVA would not apply to this scheme.
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