Edited version of private ruling

Authorisation Number: 1011761814376

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Ruling

Subject: Interest Expense - Investment Loan

Question

Can you claim a deduction for the prepaid interest on an investment loan before the asset has been acquired?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You took out an investment loan to fund a purchase of a share portfolio.

The loan agreement was in you and your spouse's name.

The interest paid on the loan and the earnings relating to the share portfolio were divided in equal shares to you and your spouse.

Prior to 30 June 2010 all shares were disposed of and the whole amount of the loan was transferred back to the savings account.

The loan amount was then transferred to a share portfolio account that was only in your name.

At the end of 2010 you prepaid the interest on the loan for a period of 365 days.

Due to the volatility of the share market you have been considering the purchase of an investment property.

Since the end of 2010, when the loan was transferred into your name, the entire amount of funds has been sitting in the investment account awaiting a decision on the investment.

From this time you have been actively searching for an investment property.

As at the date of your private ruling application, more than X months after the loan was transferred into your name, you had yet to purchase an investment asset with the loan funds.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

It is considered that the interest incurred in awaiting a decision on the purchase of an investment property is at a point too soon to the production of assessable income. As such the prepaid interest expense for your investment loan is not an allowable deduction.

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, or are necessarily incurred in carrying on a business for the purposes of gaining or producing such income, except where the outgoings are of a capital, private or domestic nature, or relate to the gaining or production of exempt income.

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 criterion. The interest incurred will be deductible to the extent that the property is used to produce assessable income.

It follows from Steele v. FC of T 99 ATC 4242 that interest incurred in a period prior to the derivation of relevant assessable income will be 'incurred in gaining or producing the assessable income' in the following circumstances:

· the interest is not incurred 'too soon', is not preliminary to the income earning activities, and is not a prelude to those activities;

· the interest is not private or domestic;

· the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost;

· the interest is incurred with one end in view, the gaining or producing of assessable income; and

· continuing efforts are undertaken in pursuit of that end.

In your case, at the end of 2010 you obtained a loan for the purpose of acquiring a portfolio of shares in your own name. However, due to the uncertain nature of the stock market you have been considering the purchase of an investment property instead. The whole amount of the funds has been sitting in the investment account waiting for a decision on a property to purchase.

Although you have stated an intention to now use the funds to purchase an investment property this does not establish a nexus to the production of assessable income. It is considered that the interest incurred in awaiting a decision on the purchase of an investment property is at a point too soon to the production of assessable income.

Therefore, the prepaid interest expense from your investment loan is not an allowable deduction under section 8-1 of the ITAA 1997.