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Ruling

Subject: The deductibility of interest and Part IVA

Questions:

1. Are you entitled to a deduction for the portion of interest expenses incurred on funds borrowed to purchase your spouse's interest in the investment property?

Answer:

Yes.

2. Are you entitled to a deduction for the portion of interest expenses incurred on funds borrowed to payout your portion of the outstanding joint loan the investment property?

Answer:

Yes.

3. Are you entitled to a deduction for the portion of interest expenses incurred on funds used to pay the associated transfer costs incurred in relation to the investment property?

Answer:

Yes.

4. Will Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to deny a deduction for any part of the interest incurred as identified above?

Answer:

No.

This ruling applies for the following period

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commenced on

1 July 2012

Relevant facts

You and your spouse purchased a home several years ago using a loan taken out in joint names.

You and your spouse now intend to purchase a new home to use as your main residence and use the existing home as an investment property.

Your spouse wishes to sell you her interest in the investment property at market value. You already have an appraisal from a real estate agent for the value of the investment property.

You intend to take out an interest only loan, solely in your name, to be used as follows:

· to pay out the existing joint loan

· to pay associated transfer costs, including stamp duty, valuation charges and professional fees; and

· with the balance to be directed to pay your spouses share of the loan for the new main residence.

The investment property will be let at market rate and you will declare all rental income and claim all expenses in relation to the investment property.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1

Income Tax Assessment Act 1936 - Part IVA

Income Tax Assessment Act 1936 - Section 177A

Income Tax Assessment Act 1936 - Section 177C

Income Tax Assessment Act 1936 - Section 177D

Income Tax Assessment Act 1936 - Section 177F

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. 

Taxation Ruling TR 95/25 considers the deductibility of interest. 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 criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed funds is considered to be incurred in gaining or producing assessable income and will be an allowable deduction. Alternatively, where borrowed funds are used for a private or domestic purpose, the interest on the borrowed funds will not be an allowable deduction.

In your case, you intend to borrow funds to purchase your spouse's share of a jointly owned property, at market value, and use the property as an investment property, producing rental income. As joint owners, the value of your spouse's portion is 50%. This amount will include your spouse's portion of the amount currently outstanding on the original loan, which you also intend to payout. You will incur associated transfer costs to purchase the property.

As the borrowed funds will be used to acquire an income producing asset, you would be entitled to a deduction for the portion of interest expenses incurred on funds borrowed to purchase your spouse's interest in the investment property. You would also be entitled to a deduction for the portion of interest expenses incurred on funds borrowed to payout your portion of the outstanding amount on the original loan and to cover the associated transfer costs.

You will not be entitled to a deduction for the portion of interest expenses incurred on the remaining funds you intend to borrow, which will be used to pay off part of the loan for your new main residence as this is a private or domestic purpose.

Application of Part IVA

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In broad terms, Part IVA will apply where the following requirements are satisfied:

· there is a scheme (see section 177A);

· a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C); and

· the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)).

The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case.

In your case, what you are proposing is a 'scheme' capable of attracting the operation of Part IVA. However, when considered in conjunction with the factors in paragraph 177D(b) of the ITAA 1936, all these factors either point against the application of Part IVA or are neutral. Therefore, Part IVA will not apply to this arrangement.