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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 transfer a further share to 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 transfer a further share to 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 transfer a further share to your spouse in the investment property and your legal interest in the property is 1%?

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 1%?

Answer

No.

Question 5

Are you entitled to a deduction for 1% of the rates and insurance expenses incurred for the investment property where your legal interest is 1%?

Answer

Yes.

Question 6

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 in 2010. Your share of the property is 99% and your spouse's share is 1%.

Your spouse owns 1% so that he could attend to matters regarding the property when necessary.

It was originally intended that you would work and pay off the property. However, due to family reasons, you are unable to work. Therefore you would like to transfer the main interest in the property to your spouse.

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

The property currently has a joint principal and interest loan. The borrowed funds have been solely used for the rental property.

You will not receive any money from your spouse for transferring the additional share of the property to him.

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.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

§ it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478),

§ there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

§ it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Interest expenses are generally deductible under section 8-1 of the ITAA 1997 to the extent that it is incurred in relation to funds used for an income producing purpose.

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.

In your case, you borrowed money to purchase an investment property with your spouse. The rental property has been rented at the market rate and your original loan to purchase your 99% ownership in the property was used to produce assessable rental income.

However, you intend to transfer 98% of the property to your spouse. You will not receive any money for this transfer. As you will not be working, you are unable to make the loan repayments. It is considered that 98% of the interest expenses on your borrowed funds no longer have the necessary character of being an income producing expense. As such the associated interest expenses are not an allowable deduction under section 8-1 of the ITAA 1997. You will only be entitled to a deduction for 1% of the interest expenses on the loan after the transfer.

Insurance and rates

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

Where you have a 1% legal interest in your rental property, you are entitled a deduction for 1% of the associated insurance and rates costs incurred for the property. You are also entitled to a deduction for 1% of 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 transferring your interest expenses on your loan to your spouse. As this is not allowed under section 8-1 of the ITAA 1997 and you are no longer entitled to 98% of the interest expense, the associated benefit has not been obtained. Accordingly the Commissioner will not make a ruling on the application of Part IVA.