Edited version of private advice

Authorisation Number: 1012648164401

Ruling

Subject: Expenses

Question 1

Are you entitled to a deduction for the interest like payment paid to your ex-spouse that relates to the period that the house is available for rent?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

In 20XX, you and your spouse separated.

A property remains in joint names, however you are responsible for mortgage repayments and insurance.

Pursuant to the Family Court Order, you are to make a lump sum payment to your ex-spouse for their share of the house. The lump sum payment must be made by the 2016-17 financial year.

You have had trouble getting a bank loan for this amount, and therefore are paying your ex-spouse an amount of $XX,XXX per year until you can make the lump sum payment. The yearly payment of $XX,XXX is in addition to the lump sum payment and does not reduce the lump sum payment.

The $XX,XXX per year is calculated as approximately 6% of the lump sum amount. This percentage rate is approximately the going interest rate for a bank at the time the Family Court Order was made.

You started to earn rental income from the property during the 2013-14 financial year.

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 or relate to the earning of exempt income.

The general principles relevant to the deductibility of interest expense are set out in Taxation Ruling TR 95/25. The test is one of characterisation and the essential character of an expense is a question of fact to be determined by reference to all the circumstances.

Where a loan is taken out, the use test is applied to determine the deductibility of the interest. This is the basic test of deductibility of interest and looks to the application of the borrowed funds as the main criteria. This 'use' test was established in FC of T v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339.

Essentially, it is the use to which the borrowed funds are put that will determine the deductibility of the interest. If the borrowed funds are used to produce assessable income, then the interest will be deductible. If the funds are used for non-income producing purposes, then the interest will not be deductible.

In your case, you have been ordered by the Family Court to pay your ex-spouse a lump sum payment in order to purchase their share of the property. As you were unable to obtain a loan to make this payment, you have been ordered to pay your ex-spouse an interest-like payment of $XX,XXX per year until you pay the lump sum amount. This interest-like payment does not reduce the lump sum payment, it is addition to it. Therefore, we consider that the $XX,XXX to be in the nature of interest.

However, a deduction is only available where the interest is incurred for an income producing purpose. Consequently, you are entitled to claim a deduction for the portion of the interest-like payment that relates to the period where the property is earning rental income.

Further issues for you to consider

In the situation where you already own the property, any borrowings made to pay to your ex-spouse as part of your financial settlement will not effect the cost base of your property.