Edited version of private ruling

Authorisation Number: 1011771996952

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Ruling

Subject: Income tax: deduction for interest incurred following the cessation of relevant income earning activities.

Question and answer

Are you entitled to a partial deduction (x%) of the interest you incur on the loans originally relating to your investment property?

Yes

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You bought a property known as property B.

You had a line of credit relating to the property B.

You had an ongoing loan and line of credit from a previously sold property (property A) which was used to finance property B.

In a previous private binding ruling issued to you it was determined that a percentage of the interest amount was deductible as the balance was used for personal purposes.

You sold property B

You retained an amount for private purposes.

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.

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.

In Placer Pacific Management Pty v. Federal Commissioner of Taxation 95 ATC 4459; (1995) 31 ATR 253 the Full Federal Court said:

In our view AGC should be taken as establishing the proposition that provided the occasion of a business outgoing is to be found in the business operations towards the gaining or producing of assessable income generally, the fact that the outgoing was incurred in a year later than the year in which the income was incurred and the fact in the meantime business in the ordinary sense may have ceased will not determine the issue of deductibility.

Taxation Ruling TR 2004/4 contains the Commissioner's views on deductions for interest incurred prior to income activities commencing or after income producing activities have ceased.

Interest expenses incurred after an income producing activity has ceased will be deductible if the occasion of the interest expense is the prior income producing activity.

Deductions for interest in such circumstances will not fail to be deductible merely because:

· the loan is not for a fixed term

· the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty, or

· the original loan is refinanced, whether once or more than once.

The nexus between the outgoings of interest and the income earning activities will be broken if you:

· keep the loan on foot for reasons un-associated with the former income earning activities, or

· make a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred.

Application to your circumstances

To calculate the new deductible amount of borrowings the amount deductible at the time of sale i reduced by the combined proceeds of the sale. The non-deductible amount represents amounts set aside for personal use.