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Edited version of private ruling
Authorisation Number: 1011807817042
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Ruling
Subject: Compound interest
Question
Are you entitled to a deduction for the interest you incur on your rental loan and line of credit?
Answer:
Yes
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 are currently building a property which you will operate as a rental property and you have already located a tenant who will move in upon completion. The rental will be managed by a real estate agent and will be at market rates.
The rental property is held as tenants in common with your spouse with shares of 99% to yourself and 1% to your spouse.
You have a loan in respect of the construction of the rental property (your rental loan).
You will obtain a line of credit from which you will fund the interest payments incurred on your rental loan.
You will incur interest on this line of credit.
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. Compound (or capitalised) 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 charge to the line of credit, the interest is compounding. Accordingly you are entitled to a deduction for the interest you incur as its character follows that of the original borrowing, which is in respect of earning assessable income.