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Edited version of your written advice
Authorisation Number: 1012735348746
Ruling
Subject: Expenses - interest deductibility
Question
Where you do not reduce your loan proportionately by the percentage of your portfolio you have sold, are you entitled to a deduction for all of the interest you incur on that loan?
Answer: No.
This ruling applies for the following period:
Year ended 30 June 2015
The scheme commences on:
1 July 2014
Relevant facts and circumstances
You have borrowed funds to purchase a portfolio of shares and managed funds.
The value of your portfolio has increased.
The outstanding balance of your loan remains unchanged.
You will dispose of part of your portfolio to reduce its total value to approximately its original value. The disposal will be subject to capital gains tax.
You will not make any repayment to the loan used to acquire the portfolio.
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 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.
Whether interest has been incurred in the course of gaining or producing assessable income generally depends on the purpose of the borrowing and the use to which the borrowed funds are put.
Where a borrowing is used to acquire an income producing asset, or relates to expenses of an income producing activity, the interest on this borrowing is considered to be incurred in the course of gaining or producing assessable income.
Taxation Ruling TR 2000/2 discusses the deductibility of interest on money drawn down under line of credit facilities and redraw facilities. It states that where money borrowed and applied to a particular use is recouped, for example, on the sale of an asset purchased with borrowed funds, that part of the outstanding balance of the mixed purpose debt can no longer be regarded as applied to that use.
In these situations, the fundamental consideration is the income producing asset that is sold, not the value of the loan or the profit that has been made.
An example contained in TR 2000/2 explains this further:
66. Bob has a mixed purpose line of credit sub-account debt of $30,000 with $20,000 applied to the purchase of a private vehicle and $10,000 applied to purchase income producing shares in company XYZ. Bob sells half the XYZ shares for $6,000 and pays that amount into the mixed purpose sub-account.
67. The debt outstanding after the repayment is related to the $20,000 applied to the purchase of the private vehicle and $5,000 of borrowed funds applied to purchase that half of the income producing XYZ shares still held by Bob.
68. The $5,000 of borrowed funds previously applied to purchase that half of the XYZ shares that were sold is no longer applied to that use after being recouped and repaid on the sale of those shares. The previously outstanding debt related to the XYZ shares is therefore reduced to $5,000 when that portion of the borrowed money recouped is repaid to the mixed purpose sub-account.
69. When the additional amount of $1,000 obtained from the sale of half the XYZ shares is paid into the mixed purpose sub-account, it is apportioned between the outstanding funds used for income producing and non-income producing purposes. That is, the payment into the mixed purpose sub-account of $1,000, in addition to that portion of the borrowed funds recouped on the sale of half the XYZ shares, reduces the outstanding debt applied to the XYZ shares still held by $200 to $4,800 and reduces the debt applied to the private vehicle by $800 to $19,200.
In the example, Bob has sold half of his shares. Therefore, half of his income producing loan ($10,000) has been reduced by the sale. With the remaining $1,000 profit apportioned between the two income producing and non-income producing portions of the loan.
In your case, you have been redrawing funds from the equity in your home to purchase shares and managed funds. Over the years, you have made a profit on your investment portfolio. You wish to take this profit and place it into a family trust, without repaying any of your loan amount.
Reducing your portfolio balance back down to the original loan amount will not retain its full deductibility. As you have sold a portion of your investment portfolio, the deduction available on your loan amount will need to apportion to reflect the sold investments, even if you do not reduce the original loan amount. This is because you no longer hold 100% of your investment portfolio.
That is, if you sell 25% of your investment portfolio, you will only be entitled to a deduction for 75% of the loan amount.