Edited version of private advice

Authorisation Number: 1052228538216

Date of advice: 6 March 2024

Ruling

Subject: Deductions - interest on refinanced loan

Question

Are you able to claim a deduction for the interest incurred on the refinanced loan?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

You own 2 properties.

Property 1 is currently your main residence does not have a mortgage.

Property 2 is currently being rented out to tenants and has a mortgage.

You intend on moving out of Property 1 and moving into Property 2.

Property 1 will be rented out and Property 2 will become your main residence.

You also intend on renovating Property 2.

You will refinance the existing loan from Property 2 to Property 1.

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 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.

This remains so even where you change the security for the loan. The deductibility of interest is determined by the use for which the borrowed money is intended and not by the security given for the borrowed money (Taxation Determination TD 93/13). The nature of the security (if any) given for the loan is irrelevant in determining the deductibility of interest (Munro's case). The security is simply a surety to your financier in the case of default of the loan and does not alter the use of the loan funds.

This use is also not altered in the case of a refinance. Paragraph 42 of TR 95/25 addresses borrowings used to repay an existing loan. The paragraph states "Interest on a new loan will be deductible if the new loan is used to repay an existing loan, which, at the time of the second borrowing, was being used in an assessable income producing activity or used in a business activity which is defined to the production of assessable income (Roberts and Smith ATC at 4388; ATR at 504).

In your circumstances you intend to move out of Property 1 which is currently your main residence and does not have a mortgage. You intend on moving into Property 2 which is currently a rental property which does have a mortgage. You intend on establishing Property 2 as your main residence and refinancing the existing loan from Property 2 to Property 1.

This means the new loan funds will be used to repay the existing loan on Property 2. However, Property 2 will be used for private purposes and will no longer be used in an assessable income producing activity.

While the new loan may be against Property 1 as the security for the loan, and the property where you will be deriving the assessable rental income, the interest you incur will not be tax deductible because the new loan funds were not used to buy Property 1.

Therefore, any interest you incur on the refinanced loan is not deductible under section 8-1 of the ITAA 1997.

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