Edited version of private ruling

Authorisation Number: 1011639791897

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: interest deductions

Question 1

Are you entitled to claim a deduction for 100% of the interest charged on your investment property loan where you have withdrawn additional deposits for private use?

Answer:

No.

Question 2

Are you entitled to claim a deduction for the portion of the interest attributable to an income producing purpose?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2009

Relevant facts

You and your spouse purchased a property to be used as your private residence.

The purchase was funded using a bank loan and you set up a separate offset account intending to make short term deposits to reduce the interest payable on the loan.

When you contacted the bank to obtain the details of your offset account, you were given the loan account details in error. As a result you made additional payments directly into your home loan instead of your offset account, reducing your loan balance.

The error was not discovered for six months.

At that time, you were in the process of setting up a business loan to purchase a business asset but due to delays you needed to access the additional funds to complete the purchase.

You withdrew an amount of money from the loan account to purchase the asset and a similar amount was re-deposited into the loan account a few weeks later when the business loan was completed.

Two months later you withdrew another amount from the loan account to purchase another asset for your business.

You withdrew a third amount two months after that from the loan account to pay a tax liability.

A few weeks later you changed your loan account to an interest only loan for a period of five years and soon after you purchased a new main residence and your old main residence became a rental property.

You then withdrew a fourth amount from the loan account to contribute towards the purchase of your new main residence and two weeks later you withdrew the remaining additional funds from the loan account. These funds were first deposited into the loan's offset account and then the balance of the offset account was transferred to the offset account for the new residence.

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. 

Taxation Ruling TR 95/25 considers the deductibility of interest. 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 Federal Commissioner of Taxation 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 criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed moneys is considered to be incurred in gaining or producing assessable income.

Taxation Ruling TR 2000/2 states that the deductibility of interest on a further borrowing of money under a redraw facility depends upon the use to which the redrawn funds are put. Where the original borrowing is for income producing purposes and the taxpayer uses the redrawn funds wholly or partly for non-income producing purposes, that part of the accrued interest attributable to the redrawn funds used for non-income producing purposes is not deductible.

In your case, you made additional payments into your loan account under the belief you were making the deposits into an offset account. You always intended to redraw the additional payments in the future to pay business and personal expenses.

However, the debt owing on what is now an investment property has already been reduced. The withdrawal of the additional funds from this loan account is regarded as a new borrowing or redraw, just as any new borrowing for a similar amount is a separate borrowing. The deductibility of the interest on that separate borrowing depends on the use of the funds and whether the interest is incurred in gaining or producing assessable income.

In your case, you made X withdrawals from the loan account and each of these is considered a 'new borrowing'. It is the use to which of these new borrowings were put that will determine the deductibility of the interest incurred on these amounts.

Two withdrawals were used to purchase business assets. As this is an income producing purpose you are entitled to a deduction for the interest incurred on these amounts.

One withdrawal was used to pay a personal tax liability. A tax liability is not considered to be incurred by a taxpayer in earning their assessable income and also is private in nature. Therefore, no deduction is allowable under section 8-1 of the ITAA 1997 for the interest incurred on this amount.

Subsection 25-5(1) of the ITAA 1997 allows a deduction for expenditure incurred in managing the taxpayer's tax affairs. However, paragraph 25-5(2)(c) of the ITAA 1997 specifically precludes a deduction under subsection 25-5(1) of the ITAA 1997 for expenses associated with borrowing money by an individual taxpayer (including payments of interest) to pay a tax liability. The interest expense incurred by the individual taxpayer is therefore not deductible under subsection 25-5(1) of the ITAA 1997 either.

The other two withdrawals were used for private purposes. One amount was used in the purchase of your new main residence and the other was deposited in an offset account. Therefore, no deduction is allowable under section 8-1 of the ITAA 1997 for the interest incurred on these amounts.

It is acknowledged that you always intended that the deposits be made to an offset account allowing you to redraw then later without affecting the balance payable on your loan. However, the Commissioner does not have any discretion to allow you a deduction for the interest incurred on the redrawn amounts used for private purposes.