Edited version of private advice

Authorisation Number: 1012646724510

Ruling

Subject: Deductions- redraw on loan - interest

Question 1

Are you entitled to a deduction in full for interest incurred on a joint loan facility used to purchase your income producing assets pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period:

1 July 2013 to 30 June 2014

The scheme commences on:

24 December 2013

Relevant facts and circumstances

You rented a residence and purchased an investment property with your spouse.

You and your spouse financed the purchase of the investment property with borrowings from a split, interest only home investment loan (one fixed and one variable) with additional funds as deposits. The loans were secured by the investment property.

The terms of the split fixed and variable accounts and a nominated, linked offset account are set out in a credit contract that was provided.

Bank statements for the accounts were provided.

The principal is debited to the fixed and variable accounts and any other amount payable (interest and fees) is debited to the offset account. Therefore, both the fixed and variable loan accounts are non-transactional.

All interest debits for the fixed and variable loan accounts are charged monthly to the offset account.

Credit in the offset account is used to reduce the daily interest on the fixed and variable loan accounts in a loan account offset arrangement.

There is a redraw facility on the variable loan account. Specifically, you can draw down on the difference between the maximum amount you should owe after making the prescribed scheduled repayments to the variable loan account and any excess payments which have reduced the amount payable on the loan account to a lesser figure than required at that time.

All account holders are able to redraw on the variable account.

The loan balances of the fixed and variable loans were not posted to the offset account as an available credit to draw on from this account.

The investment property became your private residence.

You stated that you paid out the split loan in its entirety (for the loan payout figure advised by the bank) into the offset account with your own money.

The fixed and variable home loan account statements show no repayments were actually applied to either account. Mortgage discharge fees were not applied to either account or the offset account.

On a certain date, you paid back your spouse all the funds she/he contributed towards the investment property, bought assets in your name and increased the loan on the variable account.

You did this to quarantine the account so you could use it for investment purposes and from that date you alone have used the account. Any income generated from the assets is assessable income to you.

All transactions on the offset account since that date were for your investments.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows you a deduction for any loss or outgoing that is incurred in gaining or producing your assessable income, to the extent that it is not of a private, capital or domestic nature.

The deductibility of an outgoing is determined by its essential character ( Lunney & Hayley v. Federal Commissioner of Taxation (1958) 100 CLR 478; (1958) 11 ATD 404; (1958) 7 AITR 166).

The character of interest is determined by the purpose of the borrowing. Generally, the purpose of a borrowing can be determined from the use of borrowed funds and outgoings of interest ordinarily draw their character from that use ( Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613, Kidston Goldmines Limited v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168).

It is, therefore, generally accepted that ordinary interest incurred on funds borrowed to acquire an income producing asset is an allowable deduction. Therefore, the interest on borrowings used by you and your spouse to acquire an investment property that provided you with assessable rental income is a deduction pursuant to section 8-1 of the ITAA 1997.

A change in purpose occurred when the rental property became the private residence of you and your spouse. As the asset was no longer used for income producing purposes from that date, the interest on the borrowings was no longer a deduction for that purpose pursuant to section 8-1 of the ITAA 1997.

However, you have stated that you paid out the split loan in its entirety into the joint offset account and a redraw on the offset account was used to acquire a new income producing asset. You now want to know if the interest paid on the joint variable and fixed loan is a deduction in full to you from that date as the offset account is no longer used jointly and is once again being used for investment purposes.

You believed you were paying out the split home loan when you deposited your own funds into the offset account to bring its credit to the equivalent value of the amount you borrowed through the fixed and variable investment home loan accounts. According to the terms of your credit contract this did not occur. The fixed and variable split home loan account statements show no credit was actually applied against the principal on either account. Furthermore, no mortgage discharge fees were charged to any of the accounts.

The redraw facility you believed you were using was in fact an interest offset account. An interest offset account takes into account any credit balance on the account when calculating the daily interest on the variable and fixed loan accounts. The redraw facility, as described in your credit contract, relates to a draw down on surplus credit on the actual variable account that has exceeded the contractually required payments of fees and interest.

We conclude that you did not discharge the mortgage over the investment property. Your 'loan payout' was not actually principal and interest repaid to the fixed and variable home loan accounts so cannot be regarded as a recouped amount as described in Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities. Rather, it was a transfer of money by you into the account in anticipation of a purchase of assets in your name.

The use of funds in the offset account was not an application of repaid funds on the mortgage that was available for redraw for business purposes. It was a relocation of funds into one account where it would continue to be used for your investments.

However the increase in borrowings on the variable account was for the express purpose of continuing your personal investment strategy. The funds have since been applied solely for this purpose as is evident from the bank statement for the offset account.

The additional interest incurred on the joint variable loan will take on the character of the purpose and the use to which the funds are put, which is to earn assessable income from income producing assets. The increased amount of the variable loan is a new application for an income producing purpose. Therefore, the additional interest payable on the increased borrowings on the variable account is a deduction under section 8-1 of the ITAA 1997 as from when the funds were first applied.

The variable loan account is a mixed purpose account. As such, the Commissioner will accept reasonable apportionment of the interest based on the business use of the funds over the private use of funds as a deduction. Paragraphs 19 to 21 of TR 2000/2 provide a reasonable apportionment calculation which is included here for your assistance:

19. Where interest on borrowed money accrues daily, we accept that it would be unnecessarily onerous to require a manual daily apportionment calculation. We accept that the interest accrued in a month is deductible under section 8-1 where it is calculated using an apportionment approach based on the average outstanding principal used that month for income producing purposes. The deductible portion of interest accruing in each month is calculated as follows:


total interest accrued for the month * deductible interest percentage figure

20. The deductible interest percentage figure is calculated as follows:


((A + B) / (C + D)) * 100

where

A = opening balance (beginning of month) of outstanding principal used for income producing purposes;

B = closing balance (end of month) of outstanding principal used for income producing purposes;

C = opening balance of total outstanding principal;

D = closing balance of total outstanding principal;

Note: the closing balance for one month is the opening balance for the next month.

21. Where a taxpayer makes repayments over and above the required minimum payment and the line of credit facility comprises one mixed purpose sub-account only, the taxpayer cannot choose to notionally allocate the repayments to a particular portion of the total debt, e.g., the non-income producing portion.

The question remains as to whether you are entitled to a deduction in full on the interest attributable to the increased amount of the borrowings on the variable account or whether the deduction will be shared equally with your spouse, the other mortgagee on the variable loan.

Interest earned on joint bank accounts is treated as belonging to the persons who are beneficially entitled to the income ie according to who has beneficial ownership of the money in the account (Taxation Determination TD 92/106 Income Tax: who should be assessed to interest earned on a joint bank account?).

There is a general presumption that the holders of the account have joint beneficial ownership of the money in equal shares. That presumption will be rebuttable by evidence to the contrary (Case Z7 92 ATC 131) relating to who contributed the money and in what proportions, who drew on the account, and who used the money in the account and the accrued interest as their own property.

After you had bought the assets and paid back your spouse the deposit, the offset account had a credit balance from the increased loan. You have since dedicated the additional funds borrowed on the variable loan to your investments.

Your spouse is legally responsible with you for the variable loan should you default on the loan's terms and conditions. Her/his name appears with yours on the loan contract as the borrower and the credit contract applies to her/his equally.

The interest on the variable loan is calculated daily on the balance of the variable loan account offset by any credits on the offset account. It is posted to the variable account and then the debt transferred to the offset account for payment. However, the interest charged is generated from the outstanding balance on the variable loan account. The variable loan is secured by your jointly owned private residence.

The credit contract details approving the increase in the variable loan is in both your names. Therefore, the withdrawal from the variable account and the contribution of the additional credit to the offset account was made jointly in equal contributions.

While you alone are using the increased credit for your investments and operating the account solely for your benefit, we conclude that, on balance, the beneficial ownership of the additional credit in the variable loan is a 50/50 share arrangement.

In your situation, it is accepted the interest expense you incur on the additional amount of the borrowings from the joint variable loan will be referrable to the income producing assets purchased in your name. You are therefore entitled to a deduction pursuant to section 8-1 of the ITAA 1997 for 50% of the interest expense attributable to the amount of the increase in the variable home loan that was expended on your purchase investments.