Edited version of your written advice

Authorisation Number: 1012784332114

Ruling

Subject: Interest

Question 1

Are you entitled to a deduction for interest on an unsecured loan from an overseas associate used to purchase an investment property?

Answer

Yes.

Question 2

Are you entitled to a deduction for the interest at the time it is incurred if it has not been paid and is added to the principal?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2015 - year ended 30 June 2018

The scheme commences on

1 July 2014

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

• the application for private ruling, and

• the additional documents provided.

You wanted to purchase an investment property but were unable to obtain a loan.

You negotiated with you relatives, who are foreign residents, to obtain a loan facility.

The interest rate was set according to the market unsecured interest rate.

You purchased an investment property and it is producing assessable income.

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 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. The 'use' test, established in FC of T 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 criterion.

Where a borrowing is used to acquire an assessable income producing asset, or relates to expenses of an assessable 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 95/25.

Compound (or capitalised) interest, as with ordinary interest, derives its character from the use of the original borrowings: Taxation Determination TD 2008/27.

Taxation Ruling TR 97/7 explains the meaning of 'incurred' for the purposes of section 8-1 of the ITAA 1997. It sets out general rules, settled by case law, that assist in most cases in determining whether and when a loss or outgoing has been incurred. The key principles are:

• incurred does not equate to having been paid

• the taxpayer must be definitely committed to the outgoing in the year of income. That is, it must be a presently existing liability to pay a pecuniary sum

• it is not a presently existing liability if it is contingent, and

• incurred does not include amounts which are merely impending, threatened or expected.

Whether there is a presently existing pecuniary liability in a year of income requires consideration of the facts of each case, having regard to the source of the liability.

In this case the borrowed funds have been used to purchase an investment property, which produces assessable income. Therefore, you are entitled to a deduction under section 8-1 of the ITAA 1997 for the interest you incur on this borrowing.

Where you allow interest incurred on your loan to simply charge to the loan without repayment, the interest is compounding. Accordingly you are entitled to a deduction for the interest you incur on this borrowing as its character follows that of the original borrowing, which is in respect of earning assessable income.