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Ruling

Subject: Deduction-interest

Question 1:

Is a deduction allowed for 100% of the interest charged on loan one where the funds have been used to repay your home loan?

Answer: No.

Question 2:

Is a deduction allowed for 100% of the interest charged on loan two where the funds have been used to refinance loan one?

Answer: No.

Question 3:

Is a deduction allowed for the portion of the interest on loan two that is attributable to income producing purposes?

Answer: Yes.

This ruling applies for the following periods:

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

The scheme commenced on:

1 July 2010

Relevant facts

You and your spouse borrowed funds from a financial institution to purchase your main residence.

You purchased an investment property from private funds.

The investment property is jointly owned by you.

You were provided with financial advice and you subsequently contacted a financial institution to arrange the transfer of the outstanding debt from your main residence to your investment property.

You opened up account one and drew down funds to repay the balance of your home loan.

Due to financial problems you opened up account two with a financial institution.

You borrowed funds from account two to refinance loan one and to pay rental property expenses such as repairs, rates, agent management and body corporate fees and landlord insurance.

The balance of loan account one was reduced to nil.

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 8-1.

Reasons for decision

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.

Taxation Ruling TR 95/25 provides that the deductibility of interest is determined by the use of the borrowed money. The use test looks to the application of the borrowed funds as the main criteria (Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153).

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.

However, 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. An apportionment must be made on a fair and reasonable basis.

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). That is, when a loan is refinanced, the new loan takes on the same character as the previous loan. Therefore, if an existing loan which was used for non-income producing purposes is refinanced, the character of the new loan is derived from the original borrowing, that is the new loan is also non-income producing. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities.

Home loan

In your case, you have taken out a home loan to purchase your main residence. The purchase of your residence is considered a private expense as the home was not used for income producing purposes. As such, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for any portion of the interest on your home loan.

Loan one

You secured loan one through a financial institution and drew down funds to transfer the debt from your main residence to your unencumbered investment property by providing your investment property and home as security.

The funds provided by the financial institution were used to reduce the loan balance in relation to your main residence which was not used for income producing purposes. The Commissioner has no discretion to allow the interest expense deduction where the funds are used for private purposes. Accordingly, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for any portion of the interest on loan one.

Loan two
You secured loan two through a financial institution and used the funds to refinance the outstanding debt on loan one and to fund the investment property expenses. Loan two is considered a mixed purpose loan.

You are not entitled to a deduction under section 8-1 of the ITAA 1997 for the portion of the interest on loan two which relates to the paying out of loan one, as this portion of new borrowing took on the same character as the previous borrowing from loan one, that is, the funds are still being used for non income producing purposes.

However, you are entitled to a deduction under section 8-1 of the ITAA 1997 for the portion of the interest on loan two which relates to an income producing purpose, that is, the funds that were used to pay for repairs, rates, agent management fees, body corporate fees and landlord insurance expenses in relation to the investment property.