Edited version of your private ruling

Authorisation Number: 1012459019899

Ruling

Subject: Interest and expenses before income is produced

Question

Are you entitled to a deduction for the interest you incur on a loan relating to land you purchase?

Answer

No.

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

Year ended 30 June 2017

The scheme commenced on

1 July 2012

Relevant facts and circumstances

You intend to borrow funds to purchase vacant land which cannot be developed for at least X years, which is the time estimated for the council to construct roads and provide sewerage and other infrastructure.

You intend to develop the land to generate rental income, not for any personal use.

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) provides that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature.

The principles in relation to the deductibility of expenses incurred in gaining or producing assessable income have been established through the views taken by the Courts, Boards of Review and Administrative Appeals Tribunals.

It is not necessary that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred. In Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele), the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production.
Taxation Ruling TR 2004/4, in considering the above decision, concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances:

· the interest is not incurred too soon, is not preliminary to the income earning activities, and is not a prelude to those activities

· the interest is not private or domestic

· the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost

· the interest is incurred with one end in view, the gaining or producing of assessable income, and

· continuing efforts are undertaken in pursuit of that end.

However, in Temelli v. FC of T 97 ATC 4716; (1997) 36 ATR 417 (Temelli's case), it was found that there was not a sufficient connection between the interest paid and the prospective income producing activity for a deduction to be allowed. In Temelli's case the taxpayers purchased a block of land with the intention of building a house for rental purposes. Three years later, they had not proceeded beyond having drawings and cost estimates prepared.

In distinguishing the matter from the earlier decision of Steele's case, the Court noted at 4243 that the taxpayer Steele had demonstrated the required commitment to the redevelopment of grazing land into a motel and townhouse complex. After purchasing the land, the taxpayer in Steele had in fact obtained Council assent to a zoning change, employed architects and engineers, entered into a joint venture arrangement and pursued the project with some tenacity until litigation with her collaborator put a complete stop to it. The taxpayer in Steele demonstrated her commitment from the beginning by putting $1 million into the venture plus the time, energy and considerable expense of the subsequent architectural and engineering work and negotiations with the local council, sewerage authority and prospective joint venturers and financiers. The level of commitment demonstrated by the taxpayer in Steele to the project was not an issue in the appeal to the High Court.

In Temelli's case the Court found that the taxpayers had not made a decision to proceed with the building of a house on the land for a number of years. Their lack of commitment to the project left open the possibility of there being some purpose other than gaining or producing assessable income.

Using the ATO Interpretive Decision 2001/478 as an example, the taxpayer proposed to have his rental property completed within 12 to 18 months of purchasing the land. This time frame is not considered sufficient to break the connection between the outgoings to develop the property, and the income producing activity.

In your case, you are aware that with this particular land purchase, you will be unable to undertake any building work for at least X years. It is acknowledged that your intention is to develop the property to produce rental income, however it is considered that your circumstances are similar to those of Temelli's case in that from the time you acquire the loan you will be unable to maintain the connection between outgoings and taxable income for at least X years.

Therefore it is considered that you have not demonstrated the required commitment to the project, as established in Steele, and that the necessary connection between the outgoings and the assessable income has been lost.

Therefore, you are not entitled to claim a deduction for interest relating to the loan.