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Ruling

Subject: Interest expenses

Question

Are you entitled to a deduction for the interest expenses incurred on money's borrowed from your spouse?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 2013

The scheme commenced on

I July 2012

Relevant facts

You intend to purchase an investment property.

Your spouse has savings which they will lend to you under a formal loan agreement at the current bank interest rates.

Repayments would be made regularly. The loan agreement will have provision for the situation where repayments are not made.

The property will be rented out after purchase at commercial rates.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the 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.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478, 

· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47, and

· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Generally, interest expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances.

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that 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 the High 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. The interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income.

Accordingly, it follows that if a loan is used for investment purposes from which assessable income is to be derived, the interest incurred on the loan will generally be deductible. 

In your case, you will be incurring interest on a loan. The borrowed funds are being used to acquire an investment property. You will borrow funds from your spouse. It is considered that the funds are being lent on a commercial basis. This is because

· the interest rate charged to you is equal to the current bank interest rate, and

· there will be a formal loan agreement between you and your spouse.

As the borrowed funds are being used for income producing purposes, and the loan is commercial in nature, the associated interest expenses are an allowable deduction. The fact that you are borrowing the funds from your spouse does not change the deductibility of the expense in your specific circumstances. The arrangement is not private in nature. The interest expenses incurred are an allowable deduction under section 8-1 of the ITAA 1997.