Edited version of your written advice

Authorisation Number: 1012882983255

Date of advice: 23 September 2015

Ruling

Subject: Interest on redraw from loan

Question

Are you entitled to a deduction for the interest expense relating to an amount redrawn on a rental property loan where the redrawn amount is used for non-income producing purposes?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

The scheme commenced on

1 July 2015

Relevant facts

You were an owner of two investment properties. You sold one property and from the proceeds remaining after you paid off the loan on that property you intend to pay for your children's education, pay other expenses and pay the capital gains tax.

When you received the funds you deposited them into your loan account for your other investment property. This reduced the amount outstanding on the loan. You had the intention to redraw the money from this account when needed.

You spoke with your accountant a short period later. You were advised that you had affected your ability to claim the full amount of ongoing interest charges as an expense, when redrawing the funds in the future as you had planned.

You have removed the funds from the loan account and placed them in your main bank account.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income.

Taxation Ruling TR 95/25 considers the deductibility of interest. 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. The 'use' test, established in 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 criterion. The interest will be deductible to the extent that the property is used to produce assessable income.

It is considered that a repayment to a loan account is a permanent reduction to this debt. Repayments of an amount to a loan do not create a debt due to the borrower. It simply allows the borrower the right to then draw funds to an agreed limit. These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant.

At the time that you placed the funds into the loan reducing the balance of this loan and for any subsequent redraw to have the interest deductible, the redrawn funds would have to be used for an income producing purpose.

In your case, the redrawn funds were not used for an income producing purpose therefore; the interest on the full amount of investment loan would not be deductible.

The interest on the loan will need to be apportioned between the amount that is associated with the redrawn funds and the portion of the loan that was not paid off when you made the deposit.

We acknowledge that you did not realise the tax implications when you made the deposit into the loan account of your remaining investment property. However, the Commissioner has no discretion to be able to disregard the fact that the deposit and subsequent redraw took place.