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Ruling

Subject: Deductibility of interest expense

Question

Under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), can you claim in an income year previously unclaimed interest expenses pertaining to earlier years?

Answer

No. The interest in respect of those years would need to be claimed against the profit in the year of disposal.

This ruling applies for the following periods:

1 July 2008 to 30 June 2009

1 July 2009 to 30 June 2010

1 July 2010 to 30 June 2011

The scheme commences on:

1 July 2008

Relevant facts and circumstances

The taxpayer purchased a block of land. The land was subdivided and a house was built on each block. The taxpayer's intention was to sell one house and live in the other as their main residence.

Whilst they were building the first house, no deduction was claimed for interest relating to that property. They could not sell the house and made the decision to rent the property instead. The property in question was subsequently sold.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Unless otherwise stated, all legislative references in the following Reasons for Decision are to the Income Tax Assessment Act 1997 (ITAA 1997).

Section 8-1 allows a deduction for a loss or outgoing to the extent that it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

Whether interest has been incurred in gaining or producing assessable income generally depends on the use to which the borrowed funds have been put. Where borrowed funds are used to acquire an income producing asset, the interest on the borrowed moneys is considered to be incurred in gaining or producing assessable income and, consequently, is an allowable deduction.

Taxation Ruling TR 92/4 discusses the circumstances in which losses from isolated transactions are deductible. The principles set out in the ruling would apply equally to any deductible expenses. It states at paragraph 4:

A loss from an isolated transaction is generally deductible under subsection 51(1) if:

(a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income

In order to determine if the profit would be assessable under section 6-5, and the expenses incurred in obtaining it deductible, it needs to be established whether any profit on sale constitutes income. The general circumstances in which profits on isolated transactions are considered to be income are discussed in TR 92/3.

TR 92/3 paragraph 6 states:

Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, a profit from an isolated transaction is generally income when both of the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b)   the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Your initial purpose in acquiring then developing the land was to make a gain from its subsequent sale. Despite putting the property to an alternative use for a time, that initial intention of deriving a profit through resale did not change. That is evidenced by the fact that the property ultimately did sell. While there was a delay between the completion of the property and its sale that delay was not sufficient to raise doubt as to your intentions.

TR 92/3 paragraph 13 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. In your case, having regard to all relevant facts, the transaction would be held to be commercial in nature. Consequently, the profit made constitutes assessable income for the purposes of paragraph 6 of TR 92/3.

No lump sum deduction is available in subsequent income years for interest accrued from previous years in which deductions referable to those years were not claimed. However, expenses such as interest which relate to the earning of the income from the sale of the property are deductible in the year in which the profit is made.

Please note, as any profit on the transaction is considered assessable under section 6-5, the capital gains tax provisions under Part 3-1 will not apply.