Edited version of private advice

Authorisation Number: 1012631977265

Ruling

Subject: Interest expense

Question 1

Is the interest on the portion of the Consolidated Loan that was used to repay your Loan 1 deductible?

Answer

Yes.

Question 2

Is the interest on the portion of the Consolidated Loan that was used to repay the Loan 2 component of your Loan 3 deductible?

Answer

Yes

Question 3

Is the interest on the portion of the Consolidated Loan that was used to repay the Loan 4 component of your Loan 3 deductible in full?

Answer

No. The interest deduction needs to be apportioned.

Question 4

Is the interest on the portion of the Consolidated Loan that was used to repay the accrued interest and fees on your Loan 3 deductible?

Answer

No. The interest deduction needs to be apportioned.

Question 5

Is the interest on the portion of the Consolidated Loan that was used to repay your private expenses deductible?

Answer

No.

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

Year ended 30 June 2018

The scheme commenced on

1 July 2008

Relevant facts

In 200X you took out a secured loan to consolidate a number of loans which were for investments that no longer existed, existing investments and private expenses.

The Consolidated Loan has a contracted term of 30 years, however you endeavour to repay more than the minimum with a view to settle within a shorter time period. You also endeavour not to make any more drawings in the near future.

Loan 1

At the time you took out your Consolidated Loan you also wanted to redeem your X investment and consolidate the outstanding balance on the loan into the Consolidated Loan. However, the bank did not allow you to redeem until later in the year, but you anticipated that you would need a certain amount.

As the certain amount would not come into use until later, you repaid the amount in 200X (the terms of your Consolidated Loan did not permit repayments within one month of execution). When you actually redeemed your Loan 1 investment in mid 200X the outstanding amount was slightly less than the amount you drew from the Consolidated Loan to pay this.

Loan 3

The Loan 3 was a loan you regularly drew upon to make repayments to another loan - a margin loan you used to invest in the Loan 4 investment plan. You drew an amount for this purpose. In late 200Y, the Loan 4 investment was sold and the margin loan settled, and excess proceeds were forwarded to one of your everyday accounts. This amount did not go to repaying the Loan 3.

You also drew an amount from the Loan 3 to buy an interest in a business activity. This investment remains ongoing.

You settled your Loan 3 using funds from the Consolidated Loan in early 200X.

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 you to deduct an expense to the extent that it is incurred in producing assessable income, as long as it is not capital, private or domestic in nature. When dealing with loan interest, paragraph 27 of Taxation Ruling TR 95/25 asks you to trace the 'use' to which the borrowed funds have been put and if the loan has multiple uses, apportion the loan to those respective uses.

Question 1: Is the interest on the portion of the Consolidated Loan that was used to repay your Loan 1 deductible?

Part of the Consolidated Loan was drawn in mid 200X to repay the outstanding balance of the Loan 1. Paragraph 42 of TR 95/25 explains that if a new loan is taken out to repay an existing loan, interest on the new loan will be deductible if interest on the existing loan is deductible at the time of taking.

As at mid 200X the investment your Loan 1 once financed had been redeemed, and an amount remained outstanding after applying the proceeds. Although this amount was lost and, strictly speaking, not producing any income, FC of T v. Jones 2002 ATC 4135 (Jones) showed that a loan can maintain its deductible purpose even after the income producing 'use' of that loan has ceased. Jones involved a business, but the principle applies equally to uses that are not businesslike, such as investing in shares or units (paragraph 45 of Taxation Ruling TR 2004/4).

Whether the Loan 1 maintains the deductible purpose it once had is a question of fact. The fact that the redemption proceeds were fully applied to reduce the Loan 1 is indicative here (paragraph 50 of TR 2004/4). It supports the assertion that the loan remains on foot purely as a legacy of that old use, and that no part of it has been diverted to other uses. As the Loan 1 continued to have a deductible purpose, the Consolidated Loan, to the extent it was used to repay the Loan 1, will also have a deductible purpose per paragraph 42 of TR 95/25.

Although this portion of the Consolidated Loan will have a deductible purpose, extending the Consolidated Loan as a whole or consolidating non-deductible elements into it may diminish the connection to that purpose (paragraph 13 of TR 2004/4). However, giving weight to the following circumstances, the Commissioner believes the connection will be maintained for the 2013 income year:

• You have endeavoured not to increase the Consolidated Loan in the near future and repay it in substantially less time than contracted. Although you could legally repay the entire loan immediately, this does not change the outcome (paragraph 12 of TR 2004/4).

• Although you have consolidated non-deductible elements that will, all else being equal, keep the Consolidated Loan on foot for longer and divert some of your principal repayments away from the deductible elements, the Commissioner accepts that this is not a material advantage in light of the amounts involved and your efforts to repay the loan quickly (paragraph 13 of TR 2004/4).

Question 2: Is the interest on the portion of the Consolidated Loan that was used to repay the business activity component of your Loan 3 deductible in full?

Part of Loan 3 had been used to invest in a business activity. Loans for business activities have a deductible purpose, therefore the Consolidated Loan, to the extent it was used to repay the Loan 3, will have a deductible purpose per paragraph 42 of TR 95/25.

Question 3: Is the interest on the portion of the Consolidated Loan that was used to repay the Loan 4 component of your Loan 3 deductible in full?

Part of Loan 3 had been used to make repayments to the margin loan which held your Loan 4 investment, which by early 200X had been sold. Paragraph 10 of TR 2004/4 shows that a loan to fund an income-producing use can still have a deductible purpose even after that use has ceased, provided that the loan remains on foot solely as a legacy of that old use. For this, the Commissioner considers it vital that you repay as much of the loan as possible using the proceeds from cessation (i.e. sale of your investment) pursuant to paragraph 50 of TR 2004/4.

In your case you had two loans financing the investment rather than one, but the principle applies in much the same way. The crucial aspect is that the sales proceeds are used as much as possible to repay any debt that financed the investment.

When your investment was redeemed in late 200Y you applied the proceeds to settle the margin loan, but there were additional proceeds that were not applied to the Loan 3. This amount was not used for any deductible purpose, but rather deposited into one of your everyday bank accounts for private use.

In effect part of Loan 3 had been diverted for other advantages, and it was no longer the case that this portion of liability was a legacy of that old use. Nor was it the case that it went toward a new use that could be considered deductible (paragraph 50 of TR 2004/4).

The Consolidated Loan, to the extent it was used to repay of the Loan 3, will have a deductible purpose per paragraph 42 of TR 92/25.

For loan interest in respect of an old use to remain deductible, the loan must maintain its connection to that old use. That connection could be severed where the loan begins to yield commercial advantages that are unrelated to that old use (paragraph 13 of TR 2004/4). Having regard to your bona-fide efforts to repay the Consolidated Loan quickly, the Commissioner considers that integrating non-deductible elements as you have done will not give you such a material advantage to sever that connection.

Question 4: Is the interest on the portion of the Consolidated Loan that was used to repay the accrued interest and fees on your Loan 3 deductible in full?

Part represents accrued interest and fees on the Loan 3 as at the time you closed it. Because a small portion of the Loan 3 lacked a deductible purpose, some of this amount will represent interest and fees that are not deductible. You will need to determine, on a reasonable basis, what part of this amount relates to a deductible purpose. The Consolidated Loan, to the extent it was used to pay the deductible accrued fees and interest of the Loan 3, will have a deductible purpose per paragraph 42 of TR 92/25.

Question 5: Is the interest on the portion of the Consolidated Loan that was used to repay your private expenses deductible?

As explained in Question 1, the deductibility of loan interest expense is dependent on the 'use' to which the borrowed funds have been applied. Interest on a new loan taken out to repay an existing loan will be deductible if interest on the existing loan is deductible at the time of taking.

Amounts were drawn to repay private expenses and therefore the Consolidated Loan, to the extent it was used to repay the private expenses will not have a deductible purpose.