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Edited version of your private ruling
Authorisation Number: 1012474874458
Ruling
Subject: Investment loan
Question
Where an amount has been repaid on a loan relating to two investments, are you entitled to reverse the transaction and apply the repayment to investment B first and the balance to repay some of investment A?
Answer
No.
This ruling applies for the following periods:
Year ended 30 June 2012
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 2011
Relevant facts
You have borrowed funds and used 50% for investment A and 50% for investment B.
The loan did not have sub accounts.
Several months ago, you sold your main residence and deposited funds into the investment loan with the intention of repaying investment B first and then the remaining to investment A.
After the repayment the loan balance was reduced.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasoning
Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for 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 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. Where borrowed funds are used for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income. Where a borrowing is used to acquire an income producing asset, the interest on this borrowing is generally considered to be incurred in the course of producing assessable income.
Taxation Ruling TR 2000/2 discusses the deductibility of interest on repayments and drawings against a line of credit or redraw facility. The principles in this ruling are relevant in your circumstances.
Paragraph 44 of TR 2000/2 states that the balance outstanding on a mixed purpose loan account is an undivided single debt owed by the borrower to the lender. When repayments of principal are made, it is not considered possible to direct those payments to only that part of the borrowed funds used for a particular purpose as if it were a separate debt. While it may be possible to trace the uses to which different parts of the borrowed funds are put, it is considered a repayment of principal needs to be applied proportionately to reduce the balance of the outstanding principal attributable to each use of the funds.
That is, any repayments of a loan principal need to be applied proportionately to reduce the balance of the outstanding principal attributable to each portion of the loan. It is considered that a repayment to a loan account is a permanent reduction to the debt.
In your case, you deposited funds into the loan account. That is, your debt has been reduced. As the loan relates to two investments, the repayment needs to be applied equally to each investment.
As the funds from the sale of your main residence has been used to reduce the outstanding balance of your loan, the Commissioner can only consider what actually occurred rather than what was intended to occur. The Commissioner has no discretion to ignore the previous transaction on your loan, even where the full consequences of the repayment may not have been understood.
The legislation applies to what in fact happened rather than what may have been in mind at some earlier or later point in time. As such the repayment to the loan is directed equally to both investments.
You are entitled to a deduction under section 8-1 of the ITAA 1997 for the interest on the relevant investment where it is used for commercial income producing purposes.