Edited version of your private ruling

Authorisation Number: 1012469655945

Ruling

Subject: Deductibility of interest

Question

Are you entitled to claim a deduction for interest on a loan used to partly fund the purchase of your private residence where the loan was taken out to avoid the early redemption of a term deposit?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

You partly funded the purchase of your residential home using a loan.

At the time of the purchase you had a term deposit.

You obtained the loan in order not to lose interest income by redeeming the term deposit early.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Summary

No deduction is allowed for the interest expense on a loan used to partly fund the purchase of your private residence even if the loan was taken out to avoid losing interest through the early redemption of a term deposit.

Detailed reasoning

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.

Taxation Ruling TR 95/25 deals with deductions for interest under section 8-1 of the ITAA 1997. Interest is deductible where the expense has a sufficient connection with the gaining or producing of assessable income and it is not of a capital, private or domestic nature.

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 FC of T 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.

If the borrowed money has been used to buy, or is in relation to, an income producing asset then the interest expense is an allowable deduction.

You have borrowed money to partly fund the purchase of your private residence. In general, the interest expense incurred on funds borrowed to purchase a private residence is not deductible.

Your situation is similar to that in Case Z18; AAT Case 7891 23 ATR 1132; 92 ATC 196. In that case the taxpayer, a husband and wife, sold a farm which they had worked and bought a house in a nearby town. Although they had more than enough to pay for the home without borrowing, they decided to take advantage of the husband's entitlement, as a war veteran, to a low interest loan from the Defence Services Homes Corporation. This was done in order to earn maximum interest on fixed deposits. However, the taxpayers had to obtain a bridging loan until the Corporation loan became available.

The taxpayers claimed as deductions the interest incurred on the bridging loan and on the Corporation loan. They claimed that if they had not obtained the two loans, they would have had to reduce the money on fixed deposit in order to purchase the house and would therefore have derived less income. The Administrative Appeals Tribunal (AAT) held that although the taxpayers' motive in obtaining the loan was to leave their own funds on high interest bearing deposit, the fact that the borrowed funds were used as part payment of the purchase price of their house meant that the interest expenses were not deductible. The AAT also held that the expenses were also of a private or domestic nature.

Even though the loan will allow you to avoid a reduction in interest income due to the early redemption of a term deposit, the use of the loan funds to purchase your residence is a private purpose. Accordingly the interest expense on the loan is not deductible.