Edited version of private advice

Authorisation Number: 1051986107518

Date of advice: 7 July 2022

Ruling

Subject: Deductions

Question 1

Are you entitled to a partial deduction for interest on a loan for a rental property?

Answer

Yes. You are entitled to deduct interest incurred during the period the property was used for an income producing purpose, to the extent that it has been incurred on borrowings used for an income producing purpose.

Question 2

Are you entitled to a deduction for the legal fees associated with the deed of acknowledgment?

Answer

No.

Question 3

Are you entitled to a deduction for the loan account maintenance fee?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You purchased a property in 20XX.

Your parent drew down on their banking line of credit to assist you with the purchase of the property.

You have paid all amounts relating to the loan including interest.

The property was rented out in the 20XX income year.

There was an account maintenance fee.

You consulted a lawyer to get a Deed of Acknowledgement drawn up to show that you have paid for all interest payments.

You provided the Commissioner with a spread sheet which sets out that there has been several thousand dollars of private drawdowns and no drawdowns for investment purposes after the original amount was drawn down.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25-25

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, 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.

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.

Where a person uses the drawn funds for different purposes then the line of credit account becomes a mixed purpose account. In a mixed purpose account, 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.

You are entitled to a deduction for the portion of the interest on the loan that relates to the rental of the property for the period it was rented out under section 8-1 of the ITAA 1997. You are not entitled to a deduction for any of the interest that is associated with the private draw downs.

TR 2000/2 provides the principles you should use to calculate the portion of the interest that is deductible. Where interest is calculated daily, the Commissioner accepts that it is too onerous to calculate apportionment on a daily basis and will accept apportionment calculations based on the monthly interest charge, following the formula provided in the ruling to calculate the deductible interest percentage (paragraph 20):

((A + B) / (C + D)) * 100

where

A = opening balance (beginning of month) of outstanding principal used for income producing purposes;

B = closing balance (end of month) of outstanding principal used for income producing purposes;

C = opening balance of total outstanding principal;

D = closing balance of total outstanding principal;

Note: the closing balance for one month is the opening balance for the next month.

Repayments that include a repayment of the principal cannot be allocated against one particular part of the debt, for example the amount used for non-income producing purposes. They should be apportioned using the formula above, calculated at the time of the repayment.

You are not entitled to a deduction for the legal fees associated with the deed of acknowledgment. The deed does not have sufficient connection to the income earning activity to be deductible under section 8-1 of the ITAA 1997. It is not an expense incurred in establishing the loan; it was incurred after the money was borrowed. It is therefore not deductible as a borrowing expense under section 25-25 of the ITAA 1997.

The account maintenance fee relates to the account keeping of your parent's loan account and is not your account keeping fee.

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