Edited version of your private ruling

Authorisation Number: 1012512322213

Ruling

Subject: Interest expenses

Question

Are you entitled to a deduction for interest expenses incurred on redrawn funds used to repay your other investment loan?

Answer

Yes.

This ruling applies for the following periods:

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 2013

Relevant facts

You have an investment property which is currently being rented at commercial rates.

You have an outstanding loan in relation to the property. All borrowed funds were used for the investment property.

A relation has offered you a sum of money with the proviso that at some point in the future you may have to repay this sum. No interest is being charged for this loan.

You wish to put this money into your investment loan account.

When you are required to repay the relation the money, you will redraw funds from your original investment loan to repay the loan from your relation.

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 a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. Further, interest on a new loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing.

That is, when a loan is refinanced, the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities.

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.

Where a person uses the redrawn funds for different purposes then the loan account becomes a mixed purpose account. In a mixed purpose loan, the interest must be apportioned between the income producing and non-income producing purposes. The part of the accrued interest attributable to the funds used for private purposes is not deductible.

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

Where you use redrawn funds from your investment loan to repay your loan from your relation, the interest expenses incurred on these redrawn funds is considered to be a refinancing of your investment loan. As the borrowed funds are still being used for income producing purposes, you are entitled to a deduction for the associated interest expenses incurred under section 8-1 of the ITAA 1997.