Edited version of your private ruling

Authorisation Number: 1012090552662

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Ruling

Subject: interest expenses for on overseas loan

Question 1

Are you entitled to a deduction for your share of the interest expenses on the loan with an overseas entity where the withholding requirements have not been met?

Answer

No.

Question 2

Do the interest expenses on the loan form part of the cost base if a capital gain is made in relation to the property?

Answer

Yes.

Question 3

Do the interest expenses on the loan form part of the reduced cost base if a capital loss is made in relation to the property?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2006

Year ended 30 June 2007

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on

1 July 2005

Relevant facts

The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

o the application for private ruling,

o agreement of Sale and Construction Agreement, and

o absolute sale deed.

You and your spouse entered into an agreement with developers in 20xx for the construction of an investment property.

You and your spouse entered into a housing loan with an overseas corporation. You used the money to make progressive payments to the developer during construction.

You have incurred interest expenses in relation to the loan.

You have not withheld any amounts from the interest payments.

You have lived in Australia since 20xx and are a resident of Australia for taxation purposes.

You obtained ownership of the overseas apartment in 20xx.

The property was rented in 2011.

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. Also a deduction is not allowed if a provision prevents you from deducting it.

Generally, an Australian resident can claim a deduction for interest expenses incurred on funds borrowed to purchase a property overseas if the property is used for income producing purposes.

However section 26-25 of the ITAA 1997 specifies that interest is not deductible if the withholding requirements of the Taxation Administration Act 1953 (TAA) have not been met.

Section 12-245 of Schedule 1 of the TAA provides that an entity must withhold an amount from interest that it pays to another entity if the recipient has an address outside Australia. The rate of tax on interest income, as specified in Regulation 41 of the Taxation Administration Regulations 1976, is 10%.

The withheld amounts must be paid to the Commissioner as per section 16-150 of Schedule 1 of the TAA.

In your case you and your spouse borrowed money from an overseas corporation for the construction of a rental property.

As you are making a payment to an entity outside Australia, you are required to withhold and remit 10% of the interest payments.

For example, if you pay an interest expense of $1,000 in relation to your overseas loan, you would be required to deduct and remit $100 to the Australian Tax Office, leaving $900 to be paid to the overseas finance corporation.

As you have not complied with the withholding requirement, the interest expense that you incur is specifically denied under section 26-25 of the ITAA 1997.

It is acknowledged that the property and loan are both overseas, however, the withholding tax requirements apply to you because you make interest payments to an entity outside of Australia.

Capital gains tax (CGT)

A capital gain or capital loss is made when a CGT event happens to a CGT asset you own (section 102-20 of the ITAA 1997). A capital gain is made if the amount received (called capital proceeds) from the disposal exceeds the cost base (the cost of the asset and certain other costs associated with acquiring, holding and disposing of the asset) of the CGT asset.

Subsection 110-25(4) of the ITAA 1997 provides that the third element is the costs of owning the CGT asset you incurred (but only if you acquired the asset after 20 August 1991). These costs include interest on money you borrowed to acquire the asset.

Where you acquired the CGT asset after 13 May 1997 subsection 110-45(1B) of the ITAA 1997 provides that expenditure does not form part of the second or third element of the cost base to the extent that you have deducted or can deduct it.

The costs of owning a CGT asset are not included in the reduced cost base of an asset (subsection 110-55(2) of the ITAA 1997). The reduced cost base is relevant where a capital loss is made.

In your case, subsection 110-45(1B) of the ITAA 1997 does not apply as you haven't deducted the interest and can not deduct the interest expenses as explained above. 

Therefore, where you make a capital gain in relation to your property, your interest expenditure forms part of the cost base. However, if you make a capital loss on the sale of your property, the interest expenses are not included when calculating your reduced cost base.