Edited version of private ruling

Authorisation Number: 1011716506045

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Ruling

Subject: Interest expenses

Question 1

Are you entitled to a deduction for the interest you incur on your rental loan in respect of the $10,000 drawn from the loan to repay a family loan?

Answer

Yes

Question 2

Are you entitled to a deduction for the interest you incur on your rental loan in respect of monies drawn from the loan to reimburse yourself for personal funds used while acquiring the rental property?

Answer

No

Question 3

Are you entitled to a deduction for the interest you incur on your rental loan in respect of monies drawn from the loan, placed into an account and used solely to meet periodic repayments to the rental loan?

Answer

No

Question 4

Are you entitled to a deduction for the interest you incur on your rental loan where you allow the interest to charge to the loan without payment?

Answer

Yes, apportioned to exclude any non-deductible purpose.

This ruling applies for the following period

Income year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You own a rental property jointly with your spouse.

You and your spouse obtained a loan (rental loan) to assist with the funding of the purchase of your rental property. The initial drawing of your rental loan was used solely for the acquisition of your rental property.

You borrowed an amount from a relative to assist with the part payment of the deposit for the property. You used private funds for the remaining deposit and acquisition costs.

You will draw an amount from your rental loan to repay the loan from your relative.

You wish to draw an amount from your rental loan to reimburse yourself for the private funds used to fund the deposit and acquisition costs as mentioned above.

You wish to draw an amount from the rental loan, place these funds into an account and make periodical drawings from the account to meet the repayment obligations of the rental property.

Alternatively you will allow the interest on the rental loan to charge to the rental loan without repayment, which your loan agreement allows while your loan has sufficient surplus funds available for redraw.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 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 purpose or use to which the borrowed funds have been put. 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.

Interest on a new loan used to repay an existing loan will generally also be deductible as the character of the new loan is derived from the original borrowing: Taxation Ruling TR 95/25.

Question 1

In respect of the monies withdrawn from your rental loan to repay the family loan, it is accepted this is in effect a simple refinance and the new borrowing retains the character of the original borrowing, that is, to partially fund the acquisition of a rental property. Accordingly you are entitled to a deduction for the interest you incur on the rental loan for this portion of the borrowing.

Question 2

The well settled principle of mutuality provides that you cannot earn income from yourself or lend yourself funds. The funds drawn from your rental loan to reimburse yourself for private funds are not to repay or refinance a borrowing, but to provide for future undefined private expenditure.

Question 3

Where you draw funds from your loan and place them into an account, the purpose and use of the funds may not be defined at the time of the drawing. While the funds may be used at a later point to meet your repayment obligations to your rental loan, this is not sufficient and the link or nexus is too distant and nebulous to be associated with your rental property. Accordingly you are not entitled to a deduction for interest incurred on such a drawing from your loan as it is not incurred in earning assessable income.

Question 4

Compound interest, as with ordinary interest, derives its character from the use of the original borrowings: Taxation Determination TD 2008/27.

Where you allow interest incurred on your rental loan to simply charge to the loan without repayment, the interest is compounding. Accordingly you are entitled to a deduction for the interest you incur on this portion of the borrowing as its character following that of the original borrowing, which is in respect of earning assessable income.

However, should the rental loan become a mixed purpose loan, such as for drawings made for purposes addressed under questions 2 and 3, an apportionment of the interest incurred must be made to account for any non-deductible purpose.