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Edited version of your written advice
Authorisation Number: 5010046760665
Date of advice: 7 November 2017
Ruling
Subject: Interest deductions
Question 1
Are you entitled to a deduction for the interest you incur on the loan originally relating to property W?
Answer
Yes
This ruling applies for the following period or periods:
Year ended 30 June 2017
The scheme commences on:
01 July 2016
Relevant facts and circumstances
You had Y investment properties
You have X loans covering the Y properties
Loan A was for property W and property X.
Loan B was for property X and property Y
Loan C was for property Z
You sold property W for $X
The proceeds were used to pay down Loan B and pay off Loan C
Loan B was paid down by $X
Loan C was paid off $ X
The rest of the proceeds ($X) were used for a holiday, pay off a vehicle and savings for potentially a new investment property.
Surety for Loan A is your residential property
Loan B still has an amount owing
Loan C is paid off.
Your financial institution encouraged pay-down of higher interest loans Loan B & Loan C and to maintain Loan A as the interest is lower.
Relevant legislative provisions
ITAA Section 8-1
ITAA Section 25-25
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.
Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in FC of T 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 criterion. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. Further, interest on a new loan used to repay an existing loan, or pay the interest expense incurred on an existing loan of this type will generally also be deductible as the character of the new loan is derived from the original borrowing.
Where money borrowed and applied to a particular use (the 'relevant use') is recouped in whole or in part, for example on the sale of an asset purchased with the borrowed funds, that part of the outstanding balance of the debt which had been applied to the relevant use can no longer be regarded as continuing to be applied to that use (Taxation Ruling TR 2000/2).
In your case, upon the disposal of property X, loan A can no longer be regarded as being in relation to this property. Notwithstanding this, you then used the proceeds of the sale to reduce loan B and pay out loan C. It is accepted that the 'use' or objective purpose of loan A will then be attributed to property Y and property Z. Property Y and property Z are income earning rental properties and accordingly, you are entitled to a deduction for the interest expense on loan A.
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.
In your case, upon the disposal of property W, loan A can no longer be regarded as being in relation to this property. Notwithstanding this, you then used the proceeds of the sale to reduce loan B and pay out loan C. It is accepted that the 'use' or objective purpose of loan A will then be attributed to property X, property Y and property Z. Property X, property Y and property Z are income earning rental properties and accordingly, you are entitled to a deduction for the interest expense on loan A.
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