Edited version of your written advice

Authorisation Number: 4120038137282

Date of advice: 20 November 2017

Ruling

Subject: Interest Deduction on a rental property loan

Question 1

Can I claim the full interest amount on an investment house loan as a deduction after I have redrawn from the investment account?

Answer

No

This ruling applies for the following period or periods:

Period End 30 June 201B

Period End 30 June 201C

The scheme commences on:

01 July 201A

Relevant facts and circumstances

You have an investment loan on a rental property.

You make payments on the loan on a monthly basis.

You transferred an amount on a specific date in 201A to the loan over your regular payment.

You have stated that this transfer was made in error and should have been $X.

You were out of the country at the time you made the transaction.

You made no attempt to correct the transaction at the time.

You did not notify the bank that you had made an error.

In late 201A you withdrew the overpayment from the investment loan.

You have stated that you could not correct the error earlier than that time as there were difficulties getting both signatories available to sign the documentation at the bank.

You have had advice from your accountant that you cannot claim the full amount of your interest as a deduction.

You have not used the money you withdrew for any income producing activity.

You made alterations to your residential home and made a transport purchase.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

You are not entitled to claim full interest on your loan where you have withdrawn an amount that had been paid over the required amount.

The Commissioner regards the redraw as a separate instance of borrowing to the original loan.

The Commissioner also states that the deductibility of interest on a further borrowing of money under a redraw facility depends on the use to which the redrawn funds are put. If this is for a non-income producing purpose then the interest on the redraw amount is not deductible.

Summary

You are not entitled to claim full interest on your loan where you have withdrawn an amount that had been paid over the required amount.

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.

Taxation Ruling TR 95/25 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.

Taxation Ruling TR 2000/2 contains the Commissioner's view on the deductibility of interest with regards to line of credit and redraw facilities. We consider draw-down from a line of credit account or sub account, or a redraw from a loan account, is a separate borrowing. To the extent borrowings are used for income producing purposes, that part of the accrued interest attributable to those borrowings is deductible. Conversely, that part of the accrued interest attributable to borrowings for non-income producing purposes is not deductible.

In your situation, the deposit of the $X to your loan is considered a permanent reduction or repayment to the loan. This will reduce the balance owing and will reduce the amount of interest incurred. Should the money be withdrawn from the account, it will be considered to be a redraw in relation to the loan.

The Commissioner regards the redraw as a separate instance of borrowing to the original loan. His rationale is explained in paragraphs 39-43 of Taxation Ruling TR 2000/2. He does not view the extra repayments that allow the redraw to occur, as a debt due by the lender to the borrower (you). He views the loan agreement as giving the borrower a right (subject to restrictions in some cases) to borrow a further amount up to the balance of the loan debt that would have been outstanding if the minimum loan repayments required under the loan had been made. The extra repayments have been used to discharge part of the loan and the subsequent redraw is funded by a subsequent increasing of the overall loan. The funds used pay-down the loan simply cease to exist as an asset of the borrower after being used to discharge part of the loan debt. The payment does not create a debt payable by the lender to the borrower and are not an asset of the borrower after they have been used to discharge part of the loan debt.

At paragraph 22 of Taxation Ruling TR 2000/2 the Commissioner states that the deductibility of interest on a further borrowing of money under a redraw facility depends on the use to which the redrawn funds are put. If this is for a non-income producing purpose then the interest on the redraw amount is not deductible.

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.

You used the redraw facility on your loan for private purposes. Accordingly, the interest you incur on the redrawn amount will not be an allowable deduction and the loan is now regarded as a mixed purpose loan.

In calculating the portion of the outstanding daily loan balance attributable to an income producing purpose, any repayment of principal is applied proportionately against the outstanding balance of amounts applied to income producing and non-income producing purposes respectively, at the time the repayment is made.

We acknowledge your personal circumstances that lead to the overpayment to the loan; however the Commissioner does not have any discretion to allow you to reinstate the investment loan to its prior position as the redrawn funds have been used for a non-income producing purpose

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