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Ruling

Subject: Interest deductions

Question

Are you entitled to a deduction for the interest incurred on a loan that was used to purchase the insurance bond policy?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You are looking to borrow money as an investment loan.

You will invest in an Insurance Bond.

The income will be held in the Insurance Bond for some years and perhaps for 10 years or longer.

You will look to withdraw funds only in the event that you are required a lump sum or more income.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 26AH

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 6-5(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.

It is stated in paragraph 3 of Taxation Ruling TR 2000/17 that the deductibility of interest is determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put.

Taxation Ruling IT 2504 considers the question of whether interest payable on money to purchase life assurance policies is deductible under subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936). As of 1 July 1998 subsection 51(1) of the ITAA 1936 has been replaced by section 8-1 of the ITAA 1997.

In Case Y20 91 ATC 243; AAT Case 6903 (1991) 22 ATR 3149, the Administrative Appeals Tribunal (AAT) held that interest on money borrowed to pay the premium on a life assurance policy must be characterised as part of a private transaction and not as an outlay incurred in gaining assessable income within the meaning of subsection 51(1) of the ITAA 1936.

Section 26AH of the ITAA 1936 deals with the assessability of reversionary bonuses received under short term insurance policies. A reversionary bonus is one where the entitlement to the bonus only accrues upon the maturity, forfeiture or surrender of the policy.

Subsection 26AH(6) of the ITAA 1936 provides that for risks that commenced after 7 December 1983, reversionary bonuses are assessable income in full if received within 8 years of commencement of risk, two thirds of the bonus is assessable if received within 9 years and one third of the bonus if received within 10 years.

A bonus received from a life assurance policy is not income according to ordinary concepts and therefore does not constitute assessable income under subsection 6-5(1) of the ITAA 1997 (IT 2504).

Paragraph 10 of Taxation Ruling IT 2504 points out:

any connection between the payment of the interest and the possibility of gaining assessable income by way of bonus on the life assurance policy is too remote. In the words of the High Court in Ronpibon Tin N.L and Tonkah Compound N.L. FCT (1949) 78 CLR 47, at page 57 when considering subsection 51(1), to come within the initial part of the subsection it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.

In your case, if you allow the policy to run its full term, there is no liability for taxation. The expenditure on the investment does not necessarily gain or produce income. Neither is the expenditure incidental and relevant to any operations or activities regularly carried on by you for the production of income. Even if you surrender the policy prior to the ten years and declare the bonus in your tax return, it would not alter the nature of the investment.

As your insurance bond policy does not produce any assessable income you are not entitled to claim a deduction under section 8-1 of the ITAA 1997 for the interest you have incurred on the loan used to purchase the policy.