Edited version of your written advice

Authorisation Number: 1012829471450

Date of advice: 25 June 2015

Ruling

Subject: Interest expense incurred in relation to your attempt to purchase investment properties

Question 1:

Can you claim a deduction for interest paid on the loan, borrowed to purchase an investment property?

Answer:

Yes.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Sometime in 20XX, your spouse telephoned your accountant and financial advisor to discuss the need to purchase a further rental property.

Your spouse was advised by them that they could obtain an investment property in a proposed subdivision for you.

Later in 2011 your spouse signed contracts to purchase land for the investment.

You and your spouse made a joint application to the Bank in 2011 to borrow money to purchase the property.

Later in 20XX you and your spouse attended the Bank to sign the loan documents and authorise the telegraphic transfer of the purchase funds. Both your accountant and financial advisor and other person involved in the development attended with you and your spouse to instruct you in relation to the transfer of funds.

Later on the same day in 20XX the amount of money was disbursed by telegraphic transfer from your loan account to the bank account of the business operated by your accountant and financial advisor who was the deposit holder under the contracts.

After the funds were transferred no further action occurred in relation to the investment property.

You have endeavoured to have your money returned to you for the last three years.

You commenced legal proceeding in late 20YY by engaging lawyers to recover your money.

You issued a statutory demand via your lawyers. This demand was served on a company, (a related entity of your accountant and financial advisor) for the unpaid debt of the amount owing to you. The statutory demand has expired.

You are now proceeding to wind up the company on the grounds of insolvency. This action will discover what assets can be realised and what dividend the liquidator will be able to payout to you.

For the period from late 20XX to recently you and your spouse have paid interest relating to the borrowing of a certain amount.

The following documents are to be read with and form part of the scheme for the purposes of this private binding ruling:

• Copy of letter addressed to you from the lawyers of a certain date titled 'Re: Options For Recovery Of Money And Advice';

• Copy of the Consent of Liquidator form - In the matter of you (applicant) and the company (respondent), of recent date;

• Copy of land contracts with a contract date of a date in 20XXto purchase land from the seller and you as the buyer of the proposed lots of land;

• Handwritten summary page of interest amounts paid by you and your spouse;

• Copies of various Bank statements in the names of you and your spouse regarding the interest paid for the loan amount.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Question 1

Summary

You can claim a deduction for the interest you have paid on the loan, borrowed to purchase an investment property.

Detailed reasoning

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 deductibility of interest is typically determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put (Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613, FC of T v. Energy Resources of Australia Ltd 96 ATC 4536; (1996) 33 ATR 52 and Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steeles Case)).

Hill J in Kidston Goldmines Ltd v. FC of T 91 ATC 4538 at 4545; (1991) 33 ATR 168 at 176 stated that, ordinarily the purpose of the borrowing will be ascertained from the use to which the borrowed funds are put . However, as his Honour later observed in FC of T v. JD Roberts; FC of T v. Smith 92 ATC 4380 at 4388; (1992) 23 ATR 494 at 504, a rigid tracing of funds will not always be necessary or appropriate.

Outgoings of interest are a recurrent expense. The fact that borrowed funds may be used to purchase a capital asset does not mean the interest outgoings are therefore on capital account (see Steele's Case 99 ATC 4242 at 4249; (1999) 41 ATR 139 at 148).

It is not necessary, however, that the expenditure in question produces assessable income in the same year in which the expenditure is incurred.

In Steele's Case, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. In Steeles Case, as in your case, the income producing activity did not eventuate. The Commissioner has incorporated the principles set out in Steele's Case into Taxation Ruling TR 2004/4 which sets out his views regarding claiming interest deductions before income activities have commenced or after income producing activities have ceased.

TR 2004/4, in considering the decision in Steele's Case, concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances:

• the interest is not incurred too soon, is not preliminary to the income earning activities, and is not a prelude to those activities;

• the interest is not private or domestic;

• the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income producing activities involved, that the necessary connection between the outgoings and assessable income is lost;  

• the interest is incurred with one end in view, the gaining or producing of assessable income; and  

• continuing efforts are undertaken in pursuit of that end.  

You and your spouse borrowed an amount of money to purchase proposed investment properties. Due to the developer not using the funds for the intended purpose and liquidation proceedings have commenced, the investment properties did not proceed and so you did not earn any assessable income. You undertook steps in setting up the loan and entering a contract to purchase the investment properties. As per TR 2004/4, and Steeles Case in particular, it is considered that the interest costs incurred were in relation to your future income earning activity and so are therefore deductible under section 8-1 of the ITAA 1997, despite the income earning activity never eventuating due to the developer reneging on the deal and subsequently having liquidation proceedings commenced against them.

The interest amount will need to be apportioned equally between you and your spouse and in the financial year that the interest was incurred. If you have lodged your income tax returns for the relevant years they will need to be amended to include the additional interest deductions. You will need to lodge an out of time objection to have any amendment made to the income tax assessment for the year ended 30 June 20XY because the amendment is outside the two year period of review.

General advice regarding your other questions

As per the telephone discussions between you and an ATO officer, we provide the following general advice regarding the sale of your investment properties and the CGT consequences regarding the money presently owed to you.

Sale of your investment properties

You have stated that you have had to sell three of your investment properties to pay the bank. You have advised that the contracts of sale for these properties were signed in the financial year ended 30 June 2015 and settlement will occur in the financial year ended 30 June 2016. This will mean that any capital gain or capital loss made in relation to the investment properties will need to be returned in your income tax return for the year ended 30 June 2015. It is the date of the contract that determines which year of income that any capital gain or loss is made not the year of income in which the contract is settled. This Australian Taxation Office view is contained in Taxation Determination TD 94/89 Income tax: capital gains: in what year of income is a taxpayer required for tax purposes to include a capital gain or loss in relation to land disposed of under a contract which is made in one year of income, but which is settled in a later year of income? (I have included a copy of TD 94/89 for your reference.)

Capital gains tax and claiming any capital loss regarding the money owed to you

You have advised that you are represented by lawyers and they, on your behalf are filing an application to wind up the company. The liquidator appointed will seek to recover the debt owed to you. Until the liquidator has completed their duties and formally notifies you of the outcome you will not know how much money is recovered and what the CGT consequences will be. We cannot provide any specific CGT advice about the debt until the facts are known.

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