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Edited version of your written advice
Authorisation Number: 1012779180213
Ruling
Subject: Interest expense deductibility
Question
Where amounts have been allocated to an investment loan in error, and subsequently withdrawn for the purpose of building your new primary residence, can you continue to deduct claim 100% of the interest incurred on the investment loan?
Answer
No.
This ruling applies for the following periods:
Year ended 30 June 2015
The scheme commences on:
1 July 2014
Relevant facts and circumstances
You purchased an investment property.
The property was purchased using an investment loan from a financial institution.
The investment loan account was linked to a loan offset account which was to be utilised for the purpose of depositing funds to be used to purchase a primary residence in the future.
You sold your primary residence and accidently transferred the proceeds from the sale to the investment loan account instead of the loan offset account.
On realising the error you sought financial advice and transferred the proceeds from the investment loan account to the loan offset account a short time later.
You wish to use the proceeds held in the loan offset account to purchasing a new primary residence, and continue to claim a deduction for the interest incurred in the investment loan account.
It was never your intention to deposit the proceeds from the sale of your primary residence to the investment loan account.
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 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.
Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. Interest incurred on a loan relating to a rental property will generally be deductible.
Taxation Ruling TR 2000/2 examines the treatment and consequences of payments to loans in excess of the required amount and the subsequent redrawing of these funds.
It is considered that a repayment to a loan account in excess of the required amount is a permanent reduction to this debt. Repayments of an amount to a loan do not create a debt due to the borrower, but simply allows the borrower to then draw funds from the loan to an agreed limit. These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant.
Redraws may then result in circumstances where a loan contains mixed purposes. In these instances you are entitled to a deduction for the portion of the interest of the loan which relates to an income producing purpose. Apportionment of the interest between the mixed purposes may be required. Paragraphs 19-20 of TR 2000/2 contain formulas which can be used to calculate the income producing portion of interest.
In your situation, you applied the proceeds of sale of the property to your investment loan account in error. Whilst the application of the funds was done in error, regard must be had to what actually occurred, not what your intentions were.
The depositing of the proceeds of sale of your property into the loan offset account is considered a permanent reduction to the loan. The nature of the redraw made is characterised by the use to which they have been put and an examination of their application must be made.
In this instance, the funds will be used to correct the placement of the monies deposited in error. These funds were originally intended to be deposited to your loan offset account for the purchase of a private residence, so it is appropriate to characterise these redraws as being for private or personal use. Accordingly the interest relating to these redrawn amounts relates to a private nature and as such you are not entitled to a deduction for this portion of interest.