1012936353936 | Legal database

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Edited version of your written advice

Authorisation Number: 1012936353936

Date of advice: 25 January 2016

Ruling

Subject: Interest expenses

Question 1

Is a deduction allowed for any interest expenses in relation to the portion of the investment property loan that was repaid with the proceeds from the sale of your home?

Answer

No.

Question 2

Is a deduction allowed for the interest expenses that relate to the remaining balance of the investment property loan that was refinanced?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

You jointly owned a rental property which was financed by an investment loan.

You also had your family home which was financed by another loan.

The family home was sold and proceeds from the sale were used to repay some of the investment loan.

You later opened a new account to amalgamate the balance of the investment loan and the remaining home loan.

The rental property has now been sold.

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) allows a deduction for 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.

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith 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.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Where borrowed funds are used for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income. Where a borrowing is used to acquire an income producing asset, the interest on this borrowing is generally considered to be incurred in the course of producing assessable income.

Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities provides relevant information on various loan accounts. TR 2000/2 establishes that a repayment to a loan is a permanent reduction to the loan.

In your case, $XX,XXX.XX was repaid on your investment loan. That is, your debt was reduced.

To return the balance owing on the loan to $XX,XXX.XX will require a new loan. The additional borrowings would not be for an income producing purpose, and a deduction for the associated interest incurred would not be deductible under section 8-1 of the ITAA 1997.

You are entitled to a deduction under section 8-1 of the ITAA 1997 for the interest on the balance of the loan that remained after the repayment was made where the property was used for income producing purposes.

Refinancing a loan

Interest on a new loan used to repay an existing loan will take on the same character as the original loan. That is, when an investment loan is refinanced and a person borrows to repay an existing loan, the new loan will also relate to the investment loan. Where a home loan and an investment loan are refinanced into a new loan, the new loan is a mixed purpose loan. That is the interest expense is not fully deductible.

Paragraph 44 of TR 2000/2 states that the balance outstanding on a mixed purpose loan account is an undivided single debt owed by the borrower to the lender. When repayments of principal are made, it is not considered possible to direct those payments to only that part of the borrowed funds used for a particular purpose as if it were a separate debt. While it may be possible to trace the uses to which different parts of the borrowed funds are put, it is considered a repayment of principal needs to be applied proportionately to reduce the balance of the outstanding principal attributable to each use of the funds.

That is, any repayments of a loan principal need to be applied proportionately to reduce the balance of the outstanding principal attributable to each portion of the loan.

In your case $XX,XXX.XX of your borrowed funds in your new loan related to your investment property. Where no further borrowings or redraws are made, the deductible interest expense is no more than XX.X% ($XX,XXX.XX/$XX,XXX.XX) of the total interest expense incurred. As you jointly owned the investment property, the deductible amount is shared equally according to your legal ownership in the property.

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