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Ruling

Subject: Rental property expenses - interest

Question

Are you entitled to claim a deduction for interest incurred on funds used to make progress payments after the cessation of the relative income earning activity?

Answer

Yes

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commences on

1 July 2009

Relevant facts and circumstances

You purchased a property off the plan in an overseas country. You intended to rent out the property once it was completed. You financed the purchase via various sources which were then bundled into one loan.

You continued to make progress payments in accordance with the purchase contract.

It then became apparent that the developer had become insolvent. You continued to make progress payments in the hope that the developer would recover and the development would proceed. You financed these payments using various sources and hoped to refinance the property with a bank located in the foreign country.

It then transpired that the entire development had collapsed and there was no property to refinance. You subsequently refinanced your main residence and continue to pay interest on this loan.

You do not have any other funds which would enable you to fully repay the loan.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

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, or relate to the earning of exempt income.

Taxation Ruling TR 2004/4 deals with the deductibility of interest when it is incurred prior to or after the cessation of the relevant income earning activity.

Paragraphs 10 to 14 of TR 2004/4 state the following in respect of interest incurred after the cessation of the relevant income earning activity:

Where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period.

Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgment about the nexus between the outgoing and the income earning activities.

An outgoing of interest in such circumstances will not fail to be deductible merely because:

· the loan is not for a fixed term;

· the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty; or

· the original loan is refinanced, whether once or more than once.

However, if the taxpayer:

· keeps the loan on foot for reasons unassociated with the former income earning activities; or

· makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred,

· the nexus between the outgoings of interest and the relevant income earning activities will be broken.

A legal or economic inability to repay is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities.

In your case, the original finance was obtained in order to acquire an income producing rental property. The interest on the finance is held to be incurred or gaining or producing assessable income, and is hence deductible under section 8-1 of the ITAA 1997.

As stated in TR 2004/4, if interest incurred after an income producing activity has ceased can be traced back to the original income earning activity, it will continue to be deductible. This will not change even if the loan is refinanced. As a proportion of the interest on your current loan is being charged on monies used to refinance the sources of finance used to purchase your rental property, this interest will continue to be deductible where the criteria in TR 2004/4 continue to be met as it is being incurred in relation to the original income earning activity.