Disclaimer
This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your private ruling

Authorisation Number: 1012085468848

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 deduction

Question 1

Are you entitled to a full deduction for interest incurred on your home loan where the funds were placed into a term deposit?

Answer

No.

Question 2

Are you entitled to a partial deduction for interest incurred on your home loan where the funds were placed into a term deposit?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You are an Australian resident.

You have a loan relating to your main residence.

You sold your main residence.

The proceeds from the sale were deposited into a term deposit by mistake instead of applying the proceeds to the loan.

You earned interest from your term deposit.

You incurred interest on your loan.

The interest that is incurred on the loan is higher than the interest earned from your term deposit.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Summary

A deduction for interest incurred on the loan will be allowed to the extent of the income received from the term deposit.

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 capital, private or domestic nature.

Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest will be deductible to the extent that the funds are used to produce assessable income.

The High Court in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher's Case) considered the circumstances where the interest outgoings of a taxpayer exceeded the assessable income relevant to this expense. It was found that where the assessable income derived from an arrangement is less than the relevant outgoings and the facts lead to the conclusion that there is another objective for incurring the expense, only part of the outgoing is an allowable deduction. The court found it was fair and reasonable to limit the deduction of the amount of income actually received.

Taxation Ruling TR 95/33 considers the implications of Fletcher's case. The ruling states that if an outgoing produces no assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure, including an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing, to determine whether the outgoing is wholly deductible. If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective, then the outgoing must be apportioned between the pursuit of assessable income and the other objective.

The Court took the view that if, on consideration of all those factors, the whole of the interest could be characterised as 'genuinely and not colourably incurred in gaining or producing assessable income', the interest would be fully deductible. If only part of the outgoing could be so characterised, apportionment between the pursuit of assessable income and of other objectives was necessary.

In your case, you sold your main residence. Instead of depositing the proceeds from the sale into your main residence loan account, the proceeds were deposited into a term deposit by mistake. The loan is incurring interest and the term deposit is earning interest. Your subjective purpose, motive or intention in making the outgoing (that is, the interest incurred on the loan) was a mistake. Accordingly you are entitled to a deduction for the interest expense you incur, limited to the amount of interest you earn from the term deposit.