Edited version of your private ruling

Authorisation Number: 1012034035602

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: interest expenses

Question 1

Are you entitled to a deduction for 100% of the interest expenses you incur on the refinanced loan after you acquire your spouse's half share in the investment property?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2011

Relevant facts

You and your spouse own a rental property as joint tenants.

The property currently has an interest only mortgage.

The property is currently worth over $x00,000.

Your spouse is no longer able to contribute to the property expenses.

You wish to purchase your spouse's half share in the property.

You will pay your spouse less than $15,000 cash for their share of the capital growth.

You will organise a new loan which will pay out the current joint loan. The bank requires your spouse's name to be also on the new loan.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1.

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Section 177F

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 the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which assessable income is to be derived, the interest incurred on the loan will generally be deductible. 

Interest on a loan used to repay an existing investment loan will generally be deductible to the same extent as the original loan, as the character of the new loan is derived from the original borrowing. That is, when a loan is refinanced, the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break or change the nexus between the outgoings of interest under a loan and the income earning activities.

Taxation Ruling TR 95/33 requires an examination of all the circumstances surrounding the expenditure to ensure that the interest expense could be properly characterised as genuinely, and not colourably, incurred in gaining or producing assessable income.

Income Tax Ruling IT 2167 discusses arms length arrangements with rental properties and relatives. The essential question in relation to arrangements with family members is whether the arrangements are consistent with normal commercial practices. If the arrangement is commercial, the owner of the property would be treated no differently for income tax purpose from any other owner in a comparable arms length situation.

In your case, you intend to refinance your existing joint loan. Although you will be paying all the loan expenses, the new loan will also have your spouse's name on the loan. Your original half share of the borrowings from the loan was used for the purpose of purchasing a rental property.

Although you intend to have your name as the sole owner of the rental property on the title deed, this does not automatically mean you are entitled to a deduction for your spouse's debt.

You will be acquiring sole ownership of the rental property after paying your spouse less than $15,000. As the market value of your spouse's share of the property is more than $200,000, paying her this amount is not regarded as a commercial arrangement. The arrangement to refinance and pay your spouse's debt is considered to be a private arrangement.

The interest you incur on your new loan facility for your spouse's share of the loan is not an expense incurred in gaining or producing your assessable income from the rental property. The borrowings undertaken for the other half of the new loan facility are as a result of a private arrangement between you and your spouse to discharge your spouse from further expenses.

Accordingly, the interest expenses incurred on your new refinanced loan facility will continue to be deductible for only your half share of the original loan.