Edited version of your private ruling

Authorisation Number: 1012446488582

Ruling

Subject: Loan Interest Deductibility

Question 1

Is the interest on the portion of the consolidated loan that was used to repay loan 1 deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year ruled upon?

Answer

Yes.

Question 2

Is the interest on the portion of the consolidated loan that was used to repay component one of Loan 2 deductible in full under section 8-1 of the ITAA 1997 in the income year ruled upon?

Answer

Yes.

Question 3

Is the interest on the portion of the consolidated loan that was used to repay component two of loan 2 deductible in full under section 8-1 of the ITAA 1997 in the income year ruled upon?

Answer

No. The interest deduction needs to be apportioned.

Question 4

Is the interest on the portion of the consolidated loan that was used to repay the accrued interest and fees on loan 2 deductible under section 8-1 of the ITAA 1997 in the income year ruled upon?

Answer

No. The interest deduction needs to be apportioned.

Question 5

Is the interest on the portion of the consolidated loan that was used to repay your Mortgage and Car Loan deductible under section 8-1 of the ITAA 1997 in any income year?

Answer

No.

This ruling applies for the following period:

Income year ending 30 June 2013

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

On a certain date you took out a secured loan for the amount of $1X (the consolidated loan). The purpose of this loan was to consolidate various loans you had as described below.

The funds of the consolidated loan were used for the following:

The consolidated loan has a contracted term of xx years, however you endeavour to repay more than the minimum with a view to settle within yy years. You also endeavour not to make any more drawings in the near future.

Loan 1

At the time you took out your consolidated loan you also wanted to redeem your investment and consolidate the outstanding balance on the loan into the consolidated loan. However you were not allowed to redeem this until later in the year, but you anticipated that you would need $XX, 000

As the $XX,000 would not come into use until later, you repaid the amount on 1 March 20XX (the terms of your consolidated loan did not permit repayments within one month of execution). When you actually redeemed your investment in June 20XX the outstanding amount was $yy, and you drew $X1 in the same month from the consolidated loan to pay this.

Loan 2

Loan 2 was a loan you regularly drew upon to make repayments to another loan - a margin loan you used to invest in an investment plan. You drew $X5 in total for this purpose. In December 20XX, the investment was sold and the margin loan settled, and excess proceeds of $YY were forwarded to one of your everyday accounts. This amount did not go to repaying Loan 2.

You also drew a total of $X4 from Loan 2 to buy an interest in component 2 of the investment. This investment remains ongoing.

You settled Loan 2 using funds of $XXX from the consolidated loan on 1 February 20XX, which at the time comprised of:

Mortgage and Car Loan

You paid out the balance of the mortgage on 1 February 20xxand the balance of the car loan on 6 February 20xxThe funds from these loans had been used for private purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

These reasons for decision accompany the Notice of private ruling.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Is the interest on the portion of the consolidated loan that was used to repay Loan 1 deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year ruled upon?

Answer

Yes.

Detailed reasoning

Section 8-1 of the ITAA 1997 allows you to deduct an expense to the extent that it is incurred in producing assessable income, as long as it is not capital, private or domestic in nature. When dealing with loan interest, paragraph 27 of Taxation Ruling TR 95/25 asks you to trace the 'use' to which the borrowed funds have been put and if the loan has multiple uses, apportion the loan to those respective uses.

In your case, a $X1 portion the consolidated loan was drawn on 24 June 20XX to repay the outstanding balance of Loan 1. Paragraph 42 of TR 95/25 explains that if a new loan is taken out to repay an existing loan, interest on the new loan will be deductible if interest on the existing loan is deductible at the time of taking.

As at 24 June 20xx the investment Loan 1 once financed had been redeemed, and the loan remained approximately $XX outstanding after applying the proceeds. Although this money was lost and, strictly speaking, not producing any income, FC of T v. Jones 2002 ATC 4135 (Jones) showed that a loan can maintain its deductible purpose even after the income producing 'use' of that loan has ceased. Jones involved a business, but the principle applies equally to uses that are not businesslike, such as investing in shares or units (paragraph 45 of Taxation Ruling TR 2004/4).

Whether Loan 1 maintains the deductible purpose it once had is a question of fact. The fact that the redemption proceeds were fully applied to reduce the Loan 1 is indicative here (paragraph 50 of TR 2004/4). It supports the assertion that the loan remains on foot purely as a legacy of that old use, and that no part of it has been diverted to other uses. As Loan 1 continued to have a deductible purpose, the consolidated loan, to the extent it was used to repay Loan 1, will also have a deductible purpose per paragraph 42 of TR 95/25.

Although this portion of the consolidated loan will have a deductible purpose, extending the consolidated loan as a whole or consolidating non-deductible elements into it may diminish the connection to that purpose (paragraph 13 of TR 2004/4). However, giving weight to the following circumstances, the Commissioner believes the connection will be maintained for the 2013 income year.

You have endeavoured not to increase the consolidated loan in the near future and repay it in substantially less time than contracted. Although you could legally repay the entire loan immediately, this does not change the outcome (paragraph 12 of TR 2004/4).

Although you have consolidated non-deductible elements that will, all else being equal, keep the consolidated loan on foot for longer and divert some of your principal repayments away from the deductible elements, the Commissioner accepts that this is not a material advantage in light of the amounts involved and your efforts to repay the loan quickly (paragraph 13 of TR 2004/4).

Question 2

Is the interest on the portion of the consolidated loan that was used to repay component one of Loan 2 deductible in full under section 8-1 of the ITAA 1997 in the income year ruled upon?

Answer

Yes

Detailed reasoning

Section 8-1 of the ITAA 1997 allows you to deduct an expense to the extent that it is incurred in producing assessable income, as long as it is not capital, private or domestic in nature. When dealing with loan interest, paragraph 27 of Taxation Ruling TR 95/25 asks you to trace the 'use' to which the borrowed funds have been put and if the loan has multiple uses, apportion the loan to those respective uses. Paragraph 42 of TR 95/25 explains that if a new loan is taken out to repay an existing loan, interest on the new loan will be deductible if interest on the existing loan is deductible at the time of taking.

X4 of Loan 2 had been used to invest in component one covered by particular Product Rulings Those rulings, explain that you are conducting a particular business. Loans for business activities have a deductible purpose under section 8-1 of the ITAA 1997, therefore the consolidated loan, to the extent it was used to repay This amount of the Loan 2, will have a deductible purpose per paragraph 42 of TR 95/25.

Question 3

Is the interest on the portion of the consolidated loan that was used to repay the component two of Loan 2 deductible in full under section 8-1 of the ITAA 1997 in the income year ruled upon?

Answer

No. The interest needs to be apportioned.

Detailed reasoning

X4 of Loan 2 had been used to make repayments to the margin loan which you're your component two investment, which by 1 February 20xxx had been sold. Paragraph 10 of Taxation Ruling TR 2004/4 shows that a loan to fund an income-producing use can still have a deductible purpose even after that use has ceased, provided that the loan remains on foot solely as a legacy of that old use. For this, the Commissioner considers it vital that you repay as much of the loan as possible using the proceeds from cessation (i.e. sale of your investment) pursuant to paragraph 50 of TR 2004/4.

In your case you had two loans financing the investment rather than one, but the principle applies in much the same way. The crucial aspect is that the sales proceeds are used as much as possible to repay any debt that financed the investment.

When your investment was redeemed in December 20xx you applied the proceeds to settle the margin loan, but there were additional proceeds that were not applied to Loan 2. This amount was not used for any deductible purpose, but rather deposited into one of your everyday bank accounts for private use.

In effect $xx of that loan 2 had been diverted for other advantages, and it was no longer the case that this portion of liability was a legacy of that old use. Nor was it the case that it went toward a new use that could be considered deductible (paragraph 50 of TR 2004/4).

The consolidated loan, to the extent it was used to repay some of the Loan 2, will have a deductible purpose per paragraph 42 of TR 92/25.

For loan interest in respect of an old use to remain deductible, the loan must maintain its connection to that old use. That connection could be severed where the loan begins to yield commercial advantages that are unrelated to that old use (paragraph 13 of TR 2004/4). Having regard to your bona-fide efforts to repay the consolidated loan quickly, the Commissioner considers that integrating non-deductible elements as you have done will not give you such a material advantage to sever that connection.

Question 4

Is the interest on the portion of the consolidated loan that was used to repay the accrued interest and fees on Loan 2 deductible in full under section 8-1 of the ITAA 1997 in the income year ruled upon?

Answer

No. The interest needs to be apportioned.

Detailed reasoning

$X6 represents accrued interest and fees on Loan 2 as at the time you closed it. Because a small portion of the Loan 2 lacked a deductible purpose, some of this amount will represent interest and fees that are not deductible. You will need to determine, on a reasonable basis, what part of this amount relates to a deductible purpose. The consolidated loan, to the extent it was used to pay the deductible accrued fees and interest of Loan 2 will have a deductible purpose per paragraph 42 of TR 92/25.

Question 5

Is the interest on the portion of the consolidated loan that was used to repay your mortgage and car loan deductible under section 8-1 of the ITAA 1997 in any income year?

Answer

No.

Detailed reasoning

As explained in Question 1 the deductibility of loan interest expense is dependent on the 'use' to which the borrowed funds have been applied. Interest on a new loan taken out to repay an existing loan will be deductible if interest on the existing loan is deductible at the time of taking.

$x3 and x2 were drawn to repay the mortgage and car loan respectively. Information you have provided indicates that both were used for private purposes, and therefore the Consolidated Loan, to the extent it was used to repay the mortgage and car loan, will not have a deductible purpose.