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Ruling

Subject: Investment loan interest deduction

Question 1

Are you entitled to a deduction for interest expenses incurred on the investment related portion of your loan, before the investment portion was repaid?

Answer

Yes.

Question 2

Are you entitled to a deduction for interest expenses incurred on your loan after the investment portion was repaid?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

In 2011 you borrowed funds through an investment loan to use as working capital in a partnership. You intended to use the whole amount for investment purposes, however it was decided that you would only need to use 60% of the funds in the business. You therefore used the remaining 40% for private purposes.

Soon after, the partners decided to dissolve the partnership and you were paid out the funds you invested in the business. You applied the funds to the investment loan, and were left with an outstanding balance equal to the private portion of the loan.

You are currently repaying the loan and incur interest expense.

The loan facility was not a split loan, nor a line of credit.

Relevant legislative provision

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.

Generally interest expenses incurred for income producing purposes is deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature.

Taxation Ruling TR 95/25 states that to determine whether the associated interest expenses are deductible under section 8-1 of the ITAA 1997, it is necessary to look at the use to which the borrowings are put. 

The 'use' test, established in the Federal Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Accordingly, if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. Where the interest is not solely incurred for the purpose of gaining or producing assessable income, apportionment of the expense needs to be considered.

In your case, only a portion of the loan was used for investment purposes and the remainder for private. This dual purpose means that the cost of the loan also takes on a dual character, and only that element that relates to the earning of income can be deductible. Therefore the interest on the loan must be apportioned between a business and private purpose.

Paragraph 14 of Taxation Ruling TR 95/33 (which deals with the deductibility of losses and outgoings) states:

When it is necessary to apportion a loss or outgoing, the appropriate method of apportionment will depend on the facts in each case. However, the method adopted in any particular case must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin (1949) 78 CLR 47 at 59; 8 ATD 431 at 437).

In your case, as you used 60% of the total loan amount for investment purposes and the remaining 40% for private, a 'fair and reasonable' apportionment of the interest expenses would be to allow 60% of the interest you incur as a deduction.

Consequences of the investment portion loan repayment

Taxation Ruling TR 2000/2 discusses the Commissioner's view on the consequences of making a payment off a line of credit that has been used for mixed private and business purposes. Although the ruling discusses the consequences of making a payment off a line of credit, the principle can be applied to your case.

Paragraph 45 states:

Where money borrowed and applied to a particular use is recouped, example being on the sale of an asset purchased with borrowed funds, that part of the outstanding balance of the mixed purpose debt can no longer be regarded as applied to that use. Where the borrowed funds recouped are paid into the mixed purpose account or sub-account, those funds have ceased to be outstanding funds used for any purpose. The effect of the repayment of the recouped funds to the mixed purpose sub-account is to reduce only that part of the outstanding line of credit debt applied to the previous use of those funds.

The following example outlines the practical application of these principles.

Example

Bob has a mixed purpose line of credit sub-account debt of $30,000, with $20,000 applied to the purchase of a private vehicle and $10,000 applied to the purchase of income producing shares. Bob sells half the shares for $5,000 and pays that amount into the mixed purpose sub-account. The $5,000 of borrowed funds previously applied to the purchase of half of the shares that were sold is no longer applied to that use, after being recouped and repaid on the sale of those shares. The previously outstanding debt that related to the shares is therefore reduced to $5,000 ($10,000 - $5,000) when that portion of the borrowed money recouped is repaid to the mixed purpose sub-account. The outstanding balance of the borrowed funds of $20,000 relating to the purchase of a private vehicle, is not affected by the repayment of the $5,000 relating to the sale of the shares.

Your circumstances are similar to the above example. The portion of the borrowed funds previously used as working capital in the partnership, no longer applies to that use after it was paid out to you on leaving the partnership and the funds repaid to the mixed purpose loan. After the repayment of the outstanding debt relating to the business investment was made, the balance of that portion of the loan was reduced to nil.

The outstanding loan debt which was used for private purposes is unaffected by the repayment of the investment related funds, and still retains the private or domestic nature for which it was used. As such, you are not entitled to a deduction for the interest expenses that you incur on the remaining balance of the loan after the investment portion was repaid.