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Edited version of private ruling
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Ruling
Subject: Interest deduction
Question 1
Are you entitled to a full deduction for your share of interest incurred on a reverse mortgage loan where the funds are used for investment purposes?
Answer
No.
Question 2
Are you entitled to a partial deduction for your share of interest incurred on a reverse mortgage loan where the funds are used for investment purposes?
Answer
Yes.
This ruling applies for the following periods
Year ending 30 June 2011
Year ending 30 June 2012
Year ending 30 June 2013
The scheme commenced on
1 July 2006
Relevant facts
You and your spouse took out a reverse mortgage loan, secured by your primary residence.
The full amounts of these funds were subsequently invested in order to fund your retirement.
The borrowing must be repaid in full immediately upon the completion of the sale of the security property or a demand for payment by the lender of the total amount owing.
The lender can only make a demand for payment of the total amount owing after the occurrence of any of the following:-
· the expiration of twelve calendar months after the death of the last nominated resident
· the expiration of twelve calendar months after the last nominated resident has moved into permanent long-term care
· the last nominated resident ceasing to reside in their home.
The interest is charged to your borrowing monthly on the anniversary of your settlement date, and you receive quarterly loan statements.
You and your spouse have periodically withdrawn funds from the original amount invested and used theses funds for your living expenses.
Several of the investments are held in your name only while the other is in you and your spouse's name.
You and your spouse each declare half of the interest income derived from the invested funds.
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, or relate to the earning of exempt income.
You and your spouse took out a reverse mortgage loan and invested the full amount of funds in order to fund your retirement. It is accepted that even though the majority of funds on deposit are held in your name only, the funds are being held for the benefit of both you and your spouse.
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. The interest will be deductible to the extent that the funds are used to produce assessable income.
However the High Court in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher) considered the circumstances where the interest outgoings of a taxpayer exceeded the assessable income relevant to this expense. The High Court stated that where the assessable income derived from an arrangement is less than the relevant outgoings and the facts lead to the conclusion that there is another objective for incurring the expense, only part of the outgoing is an allowable deduction. The court found it was fair and reasonable to limit the deduction of the amount of income actually received.
You and your spouse have a portion of the initial loan funds invested with several financial institutions. The rate of interest you receive for the funds invested is less than which is being charged on the reverse mortgage loan. Therefore, the amount of interest incurred on the borrowing will exceed the amount of assessable income derived from the investments, indeed this disparity will increase with the compounding of the borrowing under the reverse mortgage. As it is clear the arrangement is not commercially viable, it is reasonable to conclude an objective other than the single pursuit of earning assessable income exists.
Your circumstances are consistent with those examined in Fletcher and a deduction for interest incurred on the reverse mortgage loan will therefore only be allowed to the extent of the interest received from the invested loan funds.