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Ruling

Subject: prepaid interest expenses

Question

Are you entitled to a deduction in the 2010-11 income year for interest expenses paid in the
2011-12 income year?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on:

1 July 2010

Relevant facts and circumstances

You are not carrying on a business.

You have a managed fund.

To fund the purchase of units in the managed fund, you took out a loan that was solely for the purchase of the units.

You contacted your financial institution and advised that you wanted to pay interest in advance for the period 1 July 2011 to 30 June 2012.

Your financial institution issued you a letter advising that the interest in advance was due for payment in June 2011.

The interest was to be deducted from your account with the financial institution.

Your financial institution made an error and the interest was not deducted from your account until July 2011.

Your financial institution confirmed this was due to an error on their behalf and that the transaction should have occurred in June 2011.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1936 Section 82KZM

Income Tax Assessment Act 1936 Section 82KZL

Reasons for decision

Summary

The interest expense was incurred in the 2010-11 income year as you had a presently existing liability to pay the interest during that year. You are therefore entitled to a deduction for the interest in the 2010-11 income year.

Detailed reasoning

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.

In your case, you utilised the loan funds to purchase units in a managed fund. Income received from a managed fund is assessable income, therefore the loan interest is an allowable deduction.

When was the expense incurred?

There is no statutory definition of the term 'incurred'. However, Taxation Ruling TR 97/7 outlines general rules which will assist in most cases in defining when an outgoing is incurred.

Broadly, an expense is incurred at the time that a present money debt is owed and cannot be escaped. Importantly, a taxpayer need not have actually paid any money to have incurred such an outgoing, providing they are definitively committed to it in the year of income. That is, an expense may be incurred where there is a presently existing liability to pay a pecuniary sum (paragraph 6(a) TR 97/7).

In your case, you had a presently existing liability when you agreed to pay interest in advance and the financial institution advised you that the interest was payable in June 2011. You were definitely committed to the outgoing in the 2010-11 income year and it was only due to an error that the relevant transactions did not occur until the 2011-12 income year. Therefore, the interest expense was incurred in the 2010-11 income year.

Prepaid expenses

As you have prepaid the interest expense, the application of the prepayment rules contained in section 82KZM of the Income Tax Assessment Act 1936 (ITAA 1936) must be considered.

The effect of section 82KZM of the ITAA 1936 is to evenly spread the deduction for prepaid interest over the years comprising an eligible service period. The eligible service period is the period to which the interest relates, not exceeding 10 years (subsection 82KZL(1) of the ITAA 1936).

A prepaid expense will not be subject to these timing rules where the following factors exist:

· the interest is otherwise deductible under section 8-1 of the ITAA 1997

· the taxpayer is an individual

· the expenditure was not incurred in carrying on a business

· the eligible service period is 12 months or less, and

· the eligible service period ends in the expenditure year or the income year immediately following.

You are an individual who is not carrying on a business. The interest expense is deductible under section 8-1 of the ITAA 1997 and the eligible service period is 12 months, ending in the income year immediately following the year in which the expense was incurred. Accordingly, the interest is not subject to the prepayment rules in section 82KZM of the ITAA 1936 and is deductible in the year in which it is incurred.

Accordingly, you are entitled to claim a deduction for the prepaid interest in the 2010-11 income year.