Edited version of your private ruling

Authorisation Number: 1012578012454

Ruling

Subject: Interest deductions

Question

Are you entitled to claim the interest on a further advance on your investment loan?

Answer

No

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You had two properties and one was used as your principal place of residence (PPOR) the other was purchased in 2010 as an investment property.

Your PPOR and an investment property were used for security for two separate loans and were cross collateralised.

The loan on the investment property was $xxx. It was an interest only loan.

You sold your PPOR to a family member.

As a result of the sale the lenders required a partial discharge of the mortgage.

Due to a miscommunication between the broker and the lender on settlement of your PPOR sale, the lender retained funds to reduce the investment property mortgage.

You were unaware that the lender was retaining funds from the settlement and only discovered this was the case when all the funds were not released from the sale of your home.

Consequently, communication took place between the broker and the lender for the loan to be returned to its original amount.

The variation involved a further advance.

The further advance has been put into a savings account not associated with the loan.

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 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 that the deductibility of interest is determined by the use for which the borrowed money is put. The 'use' test, established in Federal Commissioner of Taxation 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 criteria. 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 considered to be incurred in the course of producing assessable income.

Taxation Ruling TR 2000/2 discusses the deductibility of interest on drawings against a line of credit or redraw facility. It is considered that a repayment to a loan account is a permanent reduction to the debt and any redrawn funds constitute new lending. Where a loan is for mixed purposes, a deduction is only allowed for the portion of the interest which relates to an income producing purpose.

In your case you sold your principal residence and due to a miscommunication between the broker and the lender on settlement, funds from the sale had been used to reduce your investment property mortgage.

As the balance of your loan was reduced, the deductibility of the interest on the amount of any increase in your debt is determined by the use of those additional funds. The restored funds which involved a further advance was not used for an income producing purpose as they have been deposited into a savings account not associated with the loan.

Therefore your loan is considered to be used for mixed purposes. A deduction for the interest on the further advance is not an allowable deduction under 8-1 of the ITAA 1997.