Edited version of private ruling

Authorisation Number: 1011879886120

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Ruling

Subject: Deduction-interest

Question 1:

Is a deduction allowed for 100% of the interest charged on loan A where some funds have been withdrawn for private use?

Answer: No.

Question 2:

Is a deduction allowed for 100% of the interest charged on loan B where loan B is used to refinance loan A?

Answer: No.
Question 3:

Is a deduction allowed for the portion of the interest attributable to the income producing purpose of loan B?

Answer: Yes.

This ruling applies for the following periods:

Year ended 30 June 2010
Year ended 30 June 2011
Year ending 30 June 2012
Year ending 30 June 2013
Year ending 30 June 2014
Year ending 30 June 2015
Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· your letter requesting advice

· a copy of loan agreement A

· a copy of loan agreement B

· a letter from a financial institution

· a letter from a solicitor

· statements of account

· copies of financial statements for loans A and B

· a number of emails.

You and your spouse (you) purchased an investment property.

The purchase was funded by a joint loan from a financial institution (loan A).

Income such as your salary payments were deposited into loan A.

Loan A was also used to pay private expenses.

You refinanced Loan A with a new joint loan (loan B).

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 8-1.

Reasons for decision

Summary

Taxation Ruling TR 2000/2 states that any withdrawal under a revolving credit facility represents a further borrowing. The use to which the funds from each withdrawal is put must be taken into account in determining the extent that the interest on the facility is deductible.

Although your revolving credit facility has been predominantly used to purchase an income producing asset, there have been withdrawals from the facility that were used for private purposes. Therefore, a deduction is not allowable for 100% of the interest. This is the case even though additional deposits have been made into the facility and the private withdrawals did not result in the credit facility limit being exceeded.

You are required to apportion the interest expense incurred on loan A which was used for both private and income-producing purposes. You are entitled to a deduction for the interest expense attributable to funds used for the income-producing purposes only in relation to loan A. You are not entitled to a deduction for the interest expense attributable to funds redrawn and used for private purposes on loan A.

The refinancing of loan A by funds borrowed from loan B took on the same character as loan A. Therefore, the interest expense for loan B needs to be apportioned between the income producing purposes and the non-income producing purposes in accordance with loan A.

Detailed reasoning

Interest deduction
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. 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 that is used for income producing purposes will generally also be deductible as the character of the new loan is derived from the original borrowing (Taxation Ruling TR 95/25).

Mixed purpose borrowings generally
In examining the use of borrowings, there may be instances where the loan has a mixed purpose. Where there is a mixed purpose, only the interest of the portion of the borrowing which is attributed to an income producing purpose is deductible.

Taxation Ruling TR 2000/2 (enclosed) discusses the deductibility of interest on drawings against a line of credit or redraw facility.

Apportionment of interest for mixed purpose loans
Where a loan contains mixed purposes, you are entitled to a deduction for the portion of the interest on a loan which relates to an income producing purpose. Therefore apportionment of the interest is required. An apportionment must be made on a fair and reasonable basis. The method provided in TR 2000/2 is not the only method that may be used. The onus is on the taxpayer to show that the method they have used is fair and reasonable in their circumstances. 

Taxation Ruling TR 2000/2 provides information which can be used as a guide in relation to the calculation of the apportionment of interest on line of credit facilities (paragraphs 19 to 21, TR 2000/2).

Redraws in relation to a line of credit facility
A redraw under a line of credit facility will represent new borrowings. Consequently, where the redrawn funds are used for income producing purposes for example to purchase shares or further investment properties, the accrued interest expense is deductible under section 8-1 of the ITAA 1997. TR 2000/2 provides further information in relation to further borrowings from paragraphs 39 to 44. There are two exceptions that can apply to mixed purposes line of credit sub-accounts and mixed purposes loan account repayments (refer to paragraphs 46 and 47 of TR 2000/2)

In Domjan v. Commissioner of Taxation 2004 ATC 2204; 56 ATR 1235 (Domjan's Case), the AAT confirmed the view taken by the Commissioner in TR 2000/2. In this case, the taxpayer repaid money into their investment loan account and then used the funds available in the redraw facility to pay for various personal and investment expenses. The question to be answered by the Tribunal was whether the whole of the interest incurred on the loan was a deductible expense. The Tribunal agreed that amounts redrawn from this type of loan facility constituted the new borrowing of funds and that therefore the interest payable on the amounts redrawn for private use was not deductible.

Application to your circumstances
In your case, you had an existing line of credit and you drew down funds to purchase an investment property. A review of the financial statement in relation to loan A indicates further funds were withdrawn to make payments of a private nature. Your circumstances are similar to Domjan's Case as the amounts redrawn are considered new borrowings of a private nature. Therefore, you need to apportion your interest expense in relation to loan A between income and non-income producing purposes.

When you refinanced the balance of loan A with new borrowings from loan B, the new borrowings took on the same character as the previous borrowing from loan A (paragraph 47 of TR 2000/2), that is, the funds are still being used for income and non income producing purposes.

Therefore, the interest expense on loan B needs to be apportioned between the income producing purposes and the non-income producing purposes in accordance with loan A.