Edited version of your private ruling

Authorisation Number: 1012432845471

Ruling

Subject: Interest expenses

Question

Are you entitled to a deduction for interest expenses incurred on redrawn funds used to repay another loan from a family member?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commenced on

1 July 2012

Relevant facts

You have purchased an investment rental property.

You have an investment loan with a bank. The loan is a principal and interest loan. The money was used to purchase the rental property.

A family member is offering you an interest free loan. This money will be used to reduce your bank loan and to reduce the interest payable to the bank.

In approximately one year, you will repay the family member the money by redrawing an equivalent amount from your investment loan.

Relevant legislative provisions

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.

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, it is necessary to examine 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.

Accordingly, it follows that if borrowed funds are used to purchase a rental property from which income is to be derived, the interest incurred on the loan is generally deductible. However, where a loan relates to private purpose, no deduction is allowed.

Redrawn funds

Taxation Ruling TR 2000/2 considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities.

The ruling establishes drawing any excess or available funds from the loan is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put.

In your case, where you redraw funds from your investment loan account, we need to consider the use of these funds.

Interest on a new loan used to repay an existing investment loan will generally be deductible as the character of the new loan is derived from the original borrowing. That is, where the sole purpose of the borrowing used to refinance a loan is still for income producing purposes, a deduction is still allowable.

Therefore where you use redrawn funds from your investment loan to repay your loan from your family member, the interest expenses incurred on these redrawn funds is an allowable deduction. This is because the borrowed funds are being used for income producing purposes. The nexus between your interest expenses and your assessable rental income is sufficient. Therefore a deduction is allowable under section 8-1 of the ITAA 1997.