Edited version of private ruling

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Ruling

Subject: Interest deductions

Question and answer:

Are you entitled to a deduction for interest on a loan used to purchase a dwelling you will live in?

No.

This ruling applies for the following period:

1 July 2011 to 30 June 2012.

The scheme commenced on:

1 July 2011.

Relevant facts and circumstances:

You are going to borrow money to purchase a new home to live in.

You will use an investment property as security for the loan.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Deductions for interest where the borrowed funds are used to acquire a non-income producing property

Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose. No deduction is available for interest expenses that are private or domestic in nature.

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith specifies that for an interest expense to be deductible, there must be a sufficient connection between the expense and the activities which produce assessable income.

Taxation Ruling TR 95/25 notes that 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 that this test looks at the application of the borrowed funds as the main criterion for determining the deductibility of an interest expense.

TR 95/25 specifies that the proportion of interest deductible will be equal to the proportion of the borrowed funds that are used to derive assessable income.

For example, when a taxpayer borrows money and uses 100% of the borrowed funds to acquire a rental property used to produce assessable income, there is a sufficient connection between the whole of the interest expense and the production of assessable income for the whole of the interest on the borrowed money to be deductible.

Where funds borrowed are used to fund the acquisition of an income producing property as well as a dwelling to be occupied as the residence of a taxpayer, interest deductions will only be available to the taxpayer in respect of the portion of the borrowed funds that relate to the income producing property. In cases such as this the portion of the interest expense that relates to the funds used to acquire the dwelling to be occupied by the taxpayer are private and domestic and not deductible under section 8-1 of the ITAA 1997.

The fact that an income producing property may be used as security for funds borrowed (by way of a registered mortgage for example) is irrelevant in determining whether or not the borrowed funds are being used for income producing purposes. It is the use of the funds that is relevant, not the use of the property used to secure the finance.

Conclusion

If you borrow money to purchase a dwelling you will live in and which will not produce assessable income, you are not entitled to deduct any of the interest associated with that borrowing. The use of the borrowed funds to acquire the dwelling you will live in will be considered private and domestic, regardless of the fact that you will use an income producing property as security for the borrowing.