Edited version of your written advice

Authorisation Number: 1012920753717

Date of advice: 15 December 2015

Ruling

Subject: Deduction - Rental interest

Question 1

Are you entitled to a deduction for the interest expenses incurred on an overseas loan from related parties, used to purchase a rental property, where you have met your pay as you go withholding obligations?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

You intend to acquire an investment property.

You intend to borrow the money for the investment property from your parents.

Your parents are non-residents and the loan will come from outside Australia.

The terms and conditions of the loan will be dealt with as an arm's length transaction.

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 or outgoings to the extent to which they are incurred in gaining or producing assessable income. However, you cannot deduct a loss or outgoing to the extent that the losses or outgoings are of a capital, private or domestic nature or another provision of the Act prevents you from deducting it.

Interest on borrowed money may be deductible where the money is used to acquire an income producing asset, such as a rental property. On the other hand, a repayment of the money borrowed (that is, a repayment of the principal amount borrowed) is not deductible under section 8-1 because it is capital in nature.

Taxation Ruling TR 95/25 states that the deductibility of interest is dependent upon how the borrowed funds are used. If the borrowed funds are used to purchase an income producing asset the associated interest expenses will be deductible.

You intend to borrow money from your parents in order to purchase an investment property. The terms and conditions of the loan will be arranged at arm's length.

It is accepted that you will incur interest expenses in relation to the borrowed amount from your parents.

As the interest expenses relate to earning your assessable rental income you would be entitled to a deduction for the interest expenses incurred on the loan from your parents providing there is no other provision that would deny a deduction.

Under the PAYG system, non-residents are liable for Australian tax on all assessable income earned in Australia. This includes interest, dividend and royalty income. A non-resident is liable for withholding tax on interest under subsection 128B(2) of the Income Tax Assessment Act 1936.

Under section 12-245 of the Tax Administration Act 1953 (TAA), payers of interest are required to withhold tax if:

• any of the recipients have an address outside Australia (according to any record that is in the payers possession, or records that are kept on the payers behalf about the transaction to which the interest relates), or

• the payer is authorised to pay the interest to a place outside Australia.

Payers are required to:

• withhold tax from interest paid to non-residents,

• remit the withheld amounts to the Tax Office (section 16-150 of the TAA), and

• lodge a PAYG withholding from interest, dividend and royalty payments paid to non-residents annual report (NAT 7187) (section 16-153 of the TAA).

Section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 provides that the rate of withholding tax on interest paid to non-residents is generally 10%.  

Section 26-25 of the ITAA 1997 specifies that interest is not deductible if the withholding tax requirements have not been met. Therefore, if you comply with the withholding requirements, the interest expense that you incur is deductible under section 8-1 of the ITAA 1997, as the interest expense has been incurred in producing your assessable income.