Edited version of private advice

Authorisation Number: 1012677091364

Ruling

Subject: Interest expenses

Question

Are you entitled to a deduction for interest expenses on a subsequent loan after the original amount relating to your investment property loan was paid off?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2015

The scheme commenced on

1 July 2014

Relevant facts

You have a jointly owned investment property.

In mid-2013 you withdrew some money from your home loan one to help pay for the investment property.

The interest expenses incurred in relation to your portion of the loan was claimed as a tax deduction in the 2013-14 financial year.

You purchased a new home in early 2014 and borrowed money for the purchase of your new residence. This loan is with entity A.

You sold your previous home in mid-2014 and paid off your previous home loan including the amount relating to your investment property on settlement.

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 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.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

• it must have the essential character of an outgoing incurred in gaining

assessable income or, in other words, of an income-producing expense

(Lunney v. FC of T; (1958) 100 CLR 478 (Lunney's case)),

• there must be a nexus between the outgoing and the assessable income so

that the outgoing is incidental and relevant to the gaining of assessable

income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

• it is necessary to determine the connection between the particular outgoing

and the operations or activities by which the taxpayer most directly gains or

produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v.

FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

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, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Where borrowed funds are used for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income. Where a borrowing is used to acquire an income producing asset, the interest on this borrowing is generally considered to be incurred in the course of producing assessable income.

Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities discusses the deductibility of interest on repayments and drawings against a line of credit or redraw facility. Although you may not have a line of credit account, the principles in this ruling are relevant in your circumstances.

The original application of the borrowed funds will not determine the deductibility of future funds borrowed. Paragraph 17 of TR 2000/2 states that where money borrowed and applied to a particular use is recouped, the loan can no longer be regarded as continuing to be applied to that use. Where borrowed funds are repaid and the loan balance reduces, those funds have ceased to be outstanding funds used for any purpose.

The deductibility of interest on a further borrowing of money depends upon the use to which the funds are put. Where the new funds are used for private purposes, no deduction is allowed.

Once a loan has been repaid, it no longer exists. It is considered that a repayment to a loan account is a permanent reduction to the debt. That is, where a loan has been reduced or repaid in full, this cannot be disregarded.

A future borrowing of a similar amount previously repaid on an investment loan cannot be said to be used for the investment property purchase. Any future loan cannot be reclassified into a previous loan. The use of the new funds borrowed determines the deductibility of the associated interest expenses. Where the additional borrowings are not used for an income producing purpose, a deduction for the associated interest incurred would not be deductible under section 8-1 of the ITAA 1997.

Where funds from the sale of a main residence has been used to repay an investment loan, the Commissioner can only consider what actually occurred rather than what was intended to occur. The Commissioner has no discretion to ignore a previous transaction on a loan, even where the full consequences of the repayment may not have been understood. The legislation applies to what in fact happened rather than what may have been in mind at some earlier or later point in time.

There is insufficient nexus between future interest expenses and the derivation of assessable rental income when the original investment loan has been paid out. It is the use of the borrowed funds that determine the deductibility of the associated interest expenses.

Any future borrowing cannot be reclassified or said to re-establish the original loan. That is, the repaid amount cannot be re-established and said to be for your investment property. As the new loan funds are not being used in relation to your investment property, no deduction is allowed.

We acknowledge your specific circumstances, however no deduction is allowed for interest incurred on the repaid loan or any subsequent loan of a similar amount.