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Ruling
Subject: Loan interest deduction
Question 1
Can you claim a deduction for the full amount of interest you paid on the loan while the amount borrowed was invested in the term deposit?
Answer:
No.
Question 2
Can you claim a deduction for the interest you paid on the loan while the amount borrowed was invested in the term deposit, up to the value of the interest received?
Answer
Yes.
This ruling applies for the following periods
Year ended 30 June 2011
The scheme commenced on
1 July 2010
Relevant facts
You applied for a loan to purchase a private residence. The loan was approved and the funds made available, however the residence was not ready for purchase, so you invested the available money in a high interest term deposit. You made this investment in the term deposit with the intent of making assessable income.
When the investment matured you were paid the interest.
During the time you had the borrowed money invested in the term deposit, you had to maintain the mortgage repayments on the full amount of the loan, and paid interest exceeding the interest earned on the term deposit.
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.
It is necessary to consider the essential character of the expenditure incurred to determine whether there is a sufficient connection with the assessable income earned.
The essential character of an expense is a question of fact to be determined by reference to all the circumstances.
If the expenditure produces no assessable income, or the amount of assessable income is less than the amount of the expenditure, it may be necessary to examine the circumstances surrounding the expenditure to determine whether it is wholly deductible. This may include an examination of the taxpayer's purpose or intention in incurring the expenditure.
Regard must be had to the taxpayer's purpose or intention at the time the expenditure was incurred.
When it is necessary to apportion a loss or outgoing, the appropriate method of apportionment will depend on the facts of each case. However, the method adopted in any particular case must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 78 CLR 47 at 59).
The expenditure may have been incurred, in part, for a purpose other than the production of assessable income. If this is the case the expenditure must be apportioned and a deduction allowed only to the extent that the expenditure was incurred for the income producing purpose. In Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1 the court found that it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year.
You did not borrow the money for the purpose of gaining assessable income from depositing it in a term deposit. You borrowed the funds to finance the purchase of your private residence. In these circumstances expenditure would be regarded as private or domestic in nature.
If you do earn assessable income from the investment in the term deposit this can however be considered to be a secondary purpose. The expenditure is, in part, incurred in order to earn this income. In these circumstances there is a dual purpose in incurring the expenditure and you are entitled to a deduction for a proportion of the expenditure.
In your case, the interest earned is less than the interest you paid the lender. It is considered fair and reasonable to allow a deduction for the interest expense up to the amount of the interest income earned.