Edited version of private advice

Authorisation Number: 1012636993952

Ruling

Subject: Interest expense

Question 1

Are you entitled to a deduction for the total amount of the interest paid?

Answer

No.

Question 2

Are you entitled to a deduction for interest paid up to the amount of interest received?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You sold an investment property and instead of using the proceeds to pay off the loan, you placed the funds into a term deposit account as you intended buying another investment property.

The interest rate on the term deposit was less than the interest rate on 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 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.

It is necessary to consider the essential character of the expenditure incurred to determine whether there is a sufficient connection with the assessable income earned.

The essential character of an expense is a question of fact to be determined by reference to all the circumstances. If the expenditure produces no assessable income, or the amount of assessable income is less than the amount of the expenditure, it may be necessary to examine the circumstances surrounding the expenditure to determine whether it is wholly deductible. This may include an examination of the taxpayer's purpose or intention in incurring the expenditure.

Regard must be had to the taxpayer's purpose or intention at the time the expenditure was incurred.

When it is necessary to apportion a loss or outgoing, the appropriate method of apportionment will depend on the facts of each case. However, the method adopted in any particular case must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 78 CLR 47 at 59).

The expenditure may have been incurred, in part, for a purpose other than the production of assessable income. If this is the case the expenditure must be apportioned and a deduction allowed only to the extent that the expenditure was incurred for the income producing purpose. In Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1(Fletcher's case) the court found that it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year.

You have not used the proceeds from the sale of your investment property to pay off the loan but have left these funds in a term deposit account for future purchase of another investment property. That is, your purpose is to produce the interest and also to hold the funds for a later purpose.

Even though the funds did earn assessable interest income during the period, it is clear that earning or producing assessable interest was not the primary purpose in holding the loan funds. Holding funds for a future purpose is not a deductible purpose.

Therefore, as in Fletcher's case, it is considered to be 'fair and reasonable' to limit your deduction for interest incurred to the amount of interest produced from holding the funds.