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Ruling
Subject: Personal services income and interest deductions
Question 1
Can you earn PSI through a sole trader Australian Business Number (ABN) without breaching income tax legislation?
Answer
Yes.
Question 2
Can you claim interest expense for an investment property?
Answer
Yes.
This ruling applies for the following period
Year ending 30 June 2012
The scheme commenced on
1 July 2011
Relevant facts
You earn PSI.
You do not pass any of the personal service tests and are considered to be an employee for tax purposes.
You do not intend to claim any tax deductions or divert or alienate any income to another entity.
You currently live in and own a residential property.
This property is currently used as your business address.
You plan on converting the property into an investment property.
You intend to rent and move into a separate residential property which will also serve as your business address for the duration of the lease.
You believe that rental income from your residential property is not personal services income and you intend to claim a portion of the mortgage interest for a period that the property is used as an investment property.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 84-5
Income Tax Assessment Act 1997 Section 85-10
Income Tax Assessment Act 1997 Section 86-15
Income Tax Assessment Act 1997 Section 86-60
Reasons for decision
Question 1
The Personal Services Income (PSI) Regime applies to prevent individuals from reducing their tax by alienating their PSI to an associated company, partnership, trust or individual or by claiming inappropriate "business" deductions.
Where it applies, the PSI regime has the following main effects.
· PSI is included in the assessable income of the individual whose personal efforts or skills generated the income, notwithstanding that it may have been alienated to another interposed entity.
· There are restrictions on the deductions that may be claimed by the individual or interposed entity, so that they broadly correspond to the deductions available to employees; and
· Interposed entities may have additional PAYG withholding obligations.
As you do not intend to distribute the income you earn through your sole trader business to any other entities and you intend to only claim expenses that broadly correspond to deductions available to employees, you will not breach any of the PSI tax laws in the Income Tax Assessment Act 1997 (ITAA 1997) by earning PSI as a sole trader.
Question 2
A deduction is allowed under Section 8-1 of the ITAA 1997 for any loss or outgoing that is incurred in gaining or producing assessable income to the extent that it is not of a private, capital or domestic nature. The deductibility of an outgoing is determined by its essential character.
The character of interest is determined by the reason it arises, which is usually determined by the purpose to which the borrowing is being applied when the interest arises. Generally, the purpose of a borrowing can be determined from the use of borrowed funds and outgoings of interest ordinarily draw their character from that use. Accordingly, a deduction is generally allowed for ordinary interest incurred on funds borrowed that are used to acquire an income producing asset.
As you intend to no longer continue to use the property for earning PSI, rental income earned from the property will not come under the PSI provisions of the ITAA 1997. The income earned from the investment property will form part of your ordinary assessable income and as a result the mortgage interest incurred for the period your property is used as an investment property can be deducted from your assessable income.