Edited version of your written advice

Authorisation Number: 1012674656718

Ruling

Subject: Interest expenses

Question 1

Is the income received for board assessable?

Answer

Yes.

Question 2

Are you entitled to a deduction for a portion of the interest paid that relates to the period when you received assessable income from boarders?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commenced on

1 January 2012

Relevant facts

You make payments that are in the nature of interest.

The payments relate to your property ownership.

You advertised rooms in the property and had one or two boarders stay in the house. The rent is based on the commercial rate and covers their accommodation and utility expenses.

You did not know the boarders prior to them moving in.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Assessable income

Under subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997), your assessable income includes ordinary income. Ordinary income has generally been held to include income from rendering personal services, income from property and income from carrying on a business.

Income Tax Ruling IT 2167 Income Tax: rental properties - non-economic rental, holiday home, share of residence, etc. cases, family trust cases provides guidelines about rental properties and discusses when rental income is regarded as assessable income. Where you rent out your property or part of your property, the rental income is normally regarded as ordinary income and therefore part of your assessable income.

However, as highlighted in paragraph 17 of IT 2167, where there is a non-commercial arrangement and where a payment is received for board only or for lodging only or for both then the income is considered to be a domestic arrangement not giving rise to assessable income. It follows that the question of income tax deductions for losses and outgoings does not arise.

When using your home for boarders, the essential question is whether the arrangements are consistent with normal commercial practices.

In determining whether a particular receipt is income, consideration needs to be given as to whether the intention of providing the accommodation is to make a profit or a genuine commercial relationship exists between the parties. Where these factors exist it can be argued that such receipts are in the character of assessable income (FC of T v Kowal 84 ATC 4001). However, the receipts will not be considered assessable if they merely defray the cost in looking after the boarders (FC of T v Groser 82 ATC 4478). In such cases, there is generally no gain or benefit to the home owner. Therefore, it is not reasonably arguable that they had a profit making intention.

In your case, you had one or two tenants staying in the house. The tenants are not related to you. You received an amount for board which will cover their accommodation and utility expenses. The amount is based on the local market rate. It is considered that the payments and arrangement are commercial in nature. Therefore, the payments are considered to be assessable income. 

Allowable deductions

Section 8-1 of the 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, or a provision prevents you from deducting it.

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if borrowed funds are used for investment purposes from which assessable income is to be derived, the interest incurred on the loan will generally be deductible. 

In your case, you are using the property partly for income producing purposes. 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.

Therefore, the relevant portion of the associated interest-like expenses is an allowable deduction for the periods where the property is earning assessable income from the boarders.

An apportionment of the expenses incurred on a floor area basis is an appropriate way to calculate the allowable portion that relates to the income producing use of the property.