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This edited version has been archived due to the length of time since original publication.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: 1012090613475

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 expenses - deductions

Question 1

Are you entitled to a deduction for all of the interest expenses incurred on your loan money that has been deposited into an interest bearing account?

Answer

No.

Question 2

Are you entitled to a partial deduction for the interest expenses incurred on your loan up to the amount of assessable income derived from your loan money deposited into the interest bearing account?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

The scheme commences on:

01 July 2010

Relevant facts and circumstances

Approximately two years ago you borrowed money to purchase shares.

You were expecting to receive dividends from your shares.

Soon after purchasing your shares and before you received any dividends you sold them at a loss.

At the time of sale the proceeds, from the sale of your shares, were deposited into an interest bearing account.

The proceeds are still in the same interest bearing account and are being held for other potential investments.

The interest that you pay on the loan is significantly more than the interest received from the interest bearing account.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Summary

You are entitled to a partial deduction for the interest incurred on the loan money that has been deposited into the interest bearing account. The deduction allowed is up to the amount of assessable income derived from the loan money.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature, or relates to the earning of exempt income.

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. This ruling states that there must be a sufficient connection between the interest expense and the activities which produce assessable income. To determine whether the associated interest expenses are deductible, regard must be given to all the circumstances including the purpose of the borrowing and the use to which the borrowed funds are 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 incurred will be deductible to the extent that the borrowed funds are used to produce assessable income.

Taxation Ruling TR 95/33 provides the Commissioner's view in regards to the deductibility and apportionment of losses and outgoings. This ruling states that if an outgoing produces an amount of assessable income greater than the amount of outgoing, there would normally be no need to examine the taxpayer's motives or intentions when determining the deductibility of the expenditure.

However, if the 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 to determine whether the outgoing is wholly deductible. This may, depending on the circumstances of the particular case, include an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing.

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 to the amount of income actually received.

In your case, you obtained a loan to purchase shares that were expected to generate dividends. However, after holding these shares for a short period of time you sold them and deposited the proceeds into an interest bearing account. The interest expense you incur on the loan is significantly more than the interest income you receive from the account.

The nexus between the interest expense and any potential dividends from the original shares you purchased was broken when you sold those shares and used the loan money for another purpose. The deductibility of the interest expense now depends on how you used the loan money after you sold the shares.

You had two motives for depositing the loan money into an interest bearing account:

    o To have funds available to purchase investments, such as shares, in the future.

    o To earn interest.

Your intention to use the funds to purchase an investment at a later date does not establish a nexus to the production of assessable income. The interest you incur before you purchase an investment is at a point too soon to be considered to be incurred in the production of assessable income from a future investment.

The interest derived from the account, however, is assessable income and is attributable to the funds borrowed. A deduction for some amount of interest is therefore appropriate.

Having regard to the principles set out in TR 95/33 and Fletcher's Case, it is considered that a deduction is allowable under section 8-1 of the ITAA 1997 to the extent of the assessable income received from the loan money that was deposited into your interest bearing account.