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Ruling

Subject: rental property expenses

Question 1

Are you entitled to a deduction for 100% of the interest expenses incurred on the loan after you acquire a further share from your spouse in the investment property?

Answer

No.

Question 2

Are you entitled to a deduction for 99% of the interest expenses incurred on the loan after you acquire a further share from your spouse in the investment property?

Answer

No.

Question 3

Are you entitled to a deduction for 1% of the interest expenses incurred on the loan after you acquire a further share from your spouse in the investment property?

Answer

Yes.

Question 4

Are you entitled to a deduction for 99% of the rates and insurance expenses incurred for the investment property where your legal interest is 99%?

Answer

Yes.

Question 5

Will the provisions of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the arrangement?

Answer

The Commissioner declines to make a ruling on this issue.

This ruling applies for the following period

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 purchased a rental property. Your share of the property is 1% and your spouse's share is 99%.

You own 1% so that you could attend to matters regarding the property when necessary.

It was originally intended that your spouse would work and pay off the property. However due to family reasons your spouse is unable to work. Therefore you would like to take over the property.

You wish to change the title deed to show your ownership interest as 99% and your spouse's interest as 1%.

The property currently has a principal and interest loan held jointly with your spouse. The borrowed funds have been solely used for the rental property.

You will not pay your spouse for your increased ownership in the property.

The property is rented through a real estate agent at a commercial rate.

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

Interest expenses

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. 

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.

Where two taxpayers borrow jointly, both taxpayers will have presently existing pecuniary liability to discharge interest on that borrowing once it accrues and is due and payable. Therefore, each of the borrowers will only incur their share of the interest expense, notwithstanding circumstances where one borrower may meet all repayments in respect of the borrowing (paragraph 6 of Taxation Ruling TR 97/7).

In your case, you intend to acquire an additional 98% legal interest in your rental property and pay all the loan expenses.

Although you intend to have the title deed changed to show you as legally owning 99% of the rental property, this does not automatically mean you are entitled to a deduction for your spouse's share of the debt.

You will be acquiring 99% ownership of the rental property for no cost. This is not regarded as a commercial arrangement. The arrangement to take over the loan expenses and pay your spouse's debt is considered to be a private and not a commercial arrangement.

The interest you incur on your spouse's share of the loan is not an expense incurred in gaining or producing your assessable income from the rental property. The character of the loan and associated expenses do not change when the ownership interest on the title deed changes. Agreeing to pay the interest expenses for the additional 98% interest in the property is 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 loan facility will continue to be deductible for only your 1% share of the loan.

Insurance and rates

Insurance, water charges and council rates on a rental property are allowable deductions under section 8-1 of the ITAA 1997.

After you have a 99% legal interest in your rental property, you are entitled a deduction for 99% of the associated insurance and rates costs incurred for the property. You are also entitled to a deduction for other rental property expenses such as property agent's fees while the property is rented or available for rent at a commercial rate.

Part IVA

The Commissioner may decline to make a ruling in certain situations, including circumstances where the making of the ruling would prejudice or unduly restrict the administration of a taxation law (subsection 359-35(2) of Schedule 1 to the Taxation Administration Act 1953. This includes situations where the making of a ruling would have no effect (paragraph 39 of TR 2006/11).

Part IVA of the ITAA 1936 is a general anti-avoidance rule. Part IVA gives the Commissioner the discretion to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In your case, the main tax benefit being sought related to the additional interest expenses on your loan. As this deduction is not allowed under section 8-1 of the ITAA 1997, the benefit has not been obtained. Accordingly the Commissioner will not make a ruling on the application of Part IVA.