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Ruling
Subject: Interest expenses
Question and answer:
Are you entitled to claim as a deduction the proportion of the interest expense on a loan that relates to the purchase of your managed share account?
Yes.
This ruling applies for the following period:
Year ended 30 June 2009
Year ended 30 June 2010
Year ended 30 June 2011
Year ended 30 June 2012
The scheme commenced on:
1 July 2008
Relevant facts and circumstances
You borrowed $X from a bank specifically to buy a managed share account.
The loan, though not an interest only loan, is in practice interest only because no capital has been repaid.
The investment produces income (interest, dividends and foreign source income) and capital gains. You receive about $X per year from the investment, less management fees.
The original investment of $X is now worth about $X.
You organised for $X to $X per month to be paid automatically from the share account to the loan to cover the monthly interest expenses. It was based on interest only payments, derived from bank statements.
The loan was used exclusively for your investments until a date when you increased it for other purposes. The loan is now about $X. The additional funds were not used for income producing purposes. The interest of $X to $X relates solely the investment component of the loan, i.e. the original $X.
Relevant legislation provision:
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Section 8-1 of the Income Tax Assessment Act (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 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 discusses the general principles governing the deductibility of interest. The following principles in paragraph 3 of Taxation Ruling TR 95/25 are relevant to the question of whether interest is deductible under section 8-1 of the ITAA 1997:
The interest expenses must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be of a capital, private or domestic nature. The test is one of characterisation and the essential character of an expense is a question of fact to be determined by reference to all the circumstances.
The character of the interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower. However, regard must be had to all the circumstances, including the character of your undertaking or business, the objective purpose of the borrowing, and the nature of the transaction or series of transactions of which the borrowing of funds is an element.
A tracing of the borrowed money which establishes that it has been applied to an income producing use may demonstrate the relevant connection between the interest and the income producing activity.
In your case, you borrowed $X from a bank and purchased a managed share account from which you derive assessable income. You subsequently borrowed more money on the same loan account for non income producing purposes.
As the $X you borrowed to purchase the share account is being used for the purpose of producing assessable income, you are entitled to a tax deduction under section 8-1 of the ITAA 1997 for the proportion of the interest expenses on the loan that relates to the purchase of your managed share account.