Edited version of your written advice

Authorisation Number: 1051179013852

Date of advice: 10 January 2017

Ruling

Subject: Interest expenses

Question 1

Are you entitled to a deduction for any interest following the withdrawal of money from your offset account to purchase shares?

Answer

No.

Question 2

Are you entitled to a deduction for a portion of the interest expenses incurred following the withdrawal of money from your loan account to purchase shares?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts

You have a home loan facility which includes a re-draw and an offset account.

You have purchased shares using money from a re-draw on the loan and also money from the offset account.

Both the home loan and the offset account are in your name only. The shares are also in your name only.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Interest expenses

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.

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, (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.

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 be deductible. However, where a loan relates to private purposes, no deduction is allowed.

In your case you borrowed money to purchase your home. The associated interest expenses incurred for your home loan is not an allowable deduction.

You have since used both your home loan and your offset account to purchase shares. We therefore need to determine what portion of the interest expenses incurred on the borrowed funds is deductible.

Taxation Ruling TR 93/6 Income tax and fringe benefits tax: loan account offset arrangements outlines the Commissioner's view on loan account offset arrangements which are used to reduce the interest payable on a taxpayer's loan account. TR 93/6 provides that an acceptable loan account offset arrangement with dual accounts operates as follows:   

● There are two accounts - a loan account and a deposit account. It is accepted that where the deposit account is a sub-account, it will be treated as a separate account.

● No interest is received on the deposit account.

● The reduction of the loan account interest should be achieved by offsetting the balances of the two accounts.

As highlighted in paragraph 6 of TR 93/6, to be an acceptable offset arrangement for tax purposes, it is essential that there be no entitlement, either in law or in equity, to receive interest payment or payments in the nature of interest on the amounts credited to the deposit account. The only benefit arising in the deposit account should be the right to ensure that the interest payable on the loan account is reduced.

A taxpayer with an acceptable loan account offset arrangement with dual accounts is entitled to claim a deduction for the reduced amount of interest incurred on the loan account whilst the loan is used wholly for income producing purposes.

In your case, the original loan relates to your home. As the original home loan is not used for income producing purposes, the associated interest expense is not an allowable deduction and is private in nature.

Depositing funds into the deposit account or offset will decrease the interest payable on the loan account but will not decrease the balance of the loan account.

Withdrawing funds from the deposit account will increase the interest payable on the loan account but will not increase the balance of the loan account.

In your case, as you have an offset account as well as your loan account, the loan account will operate in conjunction with the deposit account. Any credit balance of your deposit account will reduce the interest payable on your loan account.

The use of the funds in the deposit account do not alter the deductibility of the interest on the loan account. That is, where the deposits come from or whether the money from the offset account is used for private or income producing purposes does not increase or decrease the portion of interest expenses that may be deductible.

Consequently when you withdrew funds from your offset account, the interest payable on your loan increased. The fact that the funds were used to purchase shares does not convert the interest payable on your original home loan into a deductible expense.

In withdrawing money from your offset account, you have not actually incurred any interest expense.

Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out the Commissioner's views on the meaning of incurred. Generally, a taxpayer incurs an expense at the time they owe a present money debt that they cannot escape.

The guidelines developed by the courts that help to determine if an expense has been incurred include:

● there must be a presently existing liability to pay a pecuniary sum,

● presently existing liability is determined on the circumstances of the case,

● an expense is incurred when actually paid if there was no presently existing liability.

Taxation Ruling TR 94/26 Income tax: subsection 51(1) - meaning of incurred - implications of the High Court decision in Coles Myer Finance also provides the Tax Offices views on the meaning of incurred and states at paragraph 6 that: 

Whether there is a presently existing pecuniary liability is a question which must be determined in light of the particular facts of each case, and especially by reference to the terms of the contract or arrangement under which the liability is said to arise.

In your case, while it is accepted that the amount in your offset account is reduced and the interest expense on your home loan is increased, a deduction is not available for the notional expense relating to the withdrawn amounts. As your offset account was in credit and you did not actually pay any associated interest, you have not actually incurred an interest expense. You do not actually have a liability in relation to the funds withdrawn from your offset account. Therefore, no deduction is allowed under section 8-1 of the ITAA 1997.

Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities. Although your account is not a line of credit account, the principles in this ruling are relevant.

The ruling establishes drawing any excess or available funds from a loan account is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put. The redraw facilities referred to in TR 2000/2 is where a borrower redraws previous repayments of the loan principal in a loan account.

Where a person uses the redrawn funds for different purposes then the loan account becomes a mixed purpose account. In a mixed purpose loan, the interest must be apportioned between the income producing and non-income producing purposes. The part of the accrued interest attributable to the funds used for private purposes is not deductible.

Please note that the principles of TR 2000/2 apply to a loan account and not a deposit account. That is, a redraw from an offset account has no effect on the allowable portion of interest for a loan account. A withdrawal from an offset account is not a borrowing or a loan and therefore the use of the funds from an offset account is not relevant for tax purposes. That is, a redraw from an offset account is not a redraw from a loan account as discussed in TR 2000/2.

As highlighted in paragraph 40 of TR 2000/2, the redraw facility does not involve separate loan and deposit accounts as discussed in TR 93/6.

Therefore in your situation, each withdrawal from the loan account will change the portion of interest expenses deductible. However any withdrawal from your offset account will not change the previous calculated portion of interest expenses deductible.

That is, the offset account is a separate account and does not form part of the loan account or loan facility. A payment or deposit into the offset account is not a repayment of principal on the loan account.

In calculating the deductible amount of your loan, the interest must be apportioned between the income producing and non-income producing purposes of funds withdrawn from the loan account. The part of the interest expenses attributable to the funds used for private purposes such as your home is not deductible.

To determine what portion of the loan is attributable to your income producing use, you need to determine the amount of previous redraws used for private and non-income producing purposes in order to calculate the correct income producing portion of the loan. Where redraws are being made from the loan account, the deductible portion will need to be recalculated.

However any redraws from the offset account does not increase the portion of interest expenses that are allowed as a deduction.

Please note that the repayments to the loan account of the loan principal need to be applied proportionately to reduce the balance of the outstanding principal attributable to income producing use and private use. It follows that any repayment to the loan account does not change the deductible portion of interest expenses.

Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

Paragraphs 19 to 21 of TR 2000/2 sets out a method of apportioning interest on mixed purpose accounts. The ruling acknowledges that a daily apportionment of your loan expenses would be unnecessarily onerous. It is accepted that a monthly calculation of the deductible amount can be used.

Please ensure you keep accurate records in relation to your loan and method used to calculate your deducible amount.

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