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Ruling

Subject: line of credit account

Question

Are you entitled to a deduction for the interest expenses on your line of credit account according to the original investment related portion?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts

You have purchased some rental properties.

Some of the properties are owned jointly with your spouse. Other properties are owned by discretionary trusts.

You borrowed money to purchase the properties using a line of credit account.

The line of credit facility is also used for on going costs for your rental properties as well as to pay your personal living expenses.

The line of credit account is in joint names with your spouse.

Your credit card is linked to your line of credit account.

The repayments on your line of credit account are for interest only.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

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 income is to be derived, the interest incurred on the loan will be deductible. However, where a loan relates to private purposes, no deduction is allowed.

Line of credit facilities

Taxation Ruling TR 2000/2 considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities.

The ruling establishes drawing any excess or available funds from the loan is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put.

Where a person uses the redrawn funds for different purposes then the loan account becomes a mixed purpose account. In a mixed purpose loan, the interest must be apportioned between the income producing and non-income producing purposes. The part of the accrued interest attributable to the funds used for private purposes is not deductible.

Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

The apportionment method provided in TR 2000/2 is not the only method that may be used. The onus is on the taxpayer to show that the method they have used is fair and reasonable in their circumstances. 

To determine what portion of the loan is attributable to your income producing use, you need to determine the amount of previous redraws used for private and non-income producing purposes in order to calculate the correct income producing portion of the loan to be calculated. Where continuous redraws are being made, the original deductible portion will generally not be correct.

Please note, that any money borrowed and used for properties owned by a discretionary trust is not sufficiently connected to the earning of your assessable income. These borrowings relate to the assessable income of the trust which is a separate entity for taxation purposes. The fact that you may receive a distribution from the trust does not make the borrowings deductible for you.

Please also note that co-owners of a rental property divide the income and expenses for the rental property in line with their legal interest in the property (Taxation Ruling TR 93/32). Therefore 50% of the jointly owned rental property expenses do not relate to your assessable income.

Paragraphs 19 to 21 of TR 2000/2 sets out a method of apportioning interest on mixed purpose accounts. The ruling acknowledges that a daily apportionment of your loan expenses would be unnecessarily onerous. It is accepted that a monthly calculation of the deductible amount can be used.

Where the method set out in TR 2000/2 is not appropriate, the Commissioner accepts a variation of this method.

For example, where $900,000 of the original borrowed funds were used to purchase your rental properties and $100,000 of the borrowed funds related to your private expenses or in purchasing the trusts properties, only 90% of the interest expenses are an allowable deduction.

If in the following month your borrowed a further $50,000, where $30,000 related to your rental properties and $20,000 related to private and other expenses, then the deductible portion may be calculated by dividing the deductible borrowings by the total borrowings:

$900,000 + $30,000_____ _ = 88.5

$900,000 + $30,000 + $100,000 + $20,000

Therefore for that month, 88.5% of the interest expenses are deductible.

Please ensure you keep accurate records in relation to your loan and method used to calculate your deductible amount.