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Ruling
Subject: Interest on redrawn funds
Question
Are you entitled to a deduction for the interest on redrawn funds that are used to partly finance your new main residence?
Answer
No
This ruling applies for the following period
Year ended 30 June 2013
The scheme commenced on
1 July 2012
Relevant facts and circumstances
You are the owner of a rental property.
There was an outstanding mortgage owing on the property.
When your primary residence sold recently, the bank took an amount of the equity from that sale and used it to reduce the size of the mortgage loan.
You intended this to be for a short time only, and understood that you could redraw the funds when required.
You are now ready to purchase a new principle residence to live in, and wish to withdraw the funds from the rental property loan.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasons for decision
Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income.
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 criterion. The interest will be deductible to the extent that the property is used to produce assessable income.
It is considered that a repayment to a loan account is a permanent reduction to this debt. Repayments of an amount to a loan do not create a debt due to the borrower. It simply allows the borrower the right to then draw funds to an agreed limit. These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant.
In your case, even though it is acknowledged that it was a bank requirement that part of the proceeds from the sale of your house was applied against the rental property mortgage, and it was your intention that this was to be for a short time only.
This does not alter the fact that the purpose or use to which the redrawn funds are put is relevant, and in your case the redrawn funds will be used to purchase a property in which you will reside. The redrawn funds will be used for a non-income producing purpose. Therefore the interest attributable to this redrawn amount will not be deductible.