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Edited version of your written advice
Authorisation Number: 1012927034177
Date of advice: 17 December 2015
Ruling
Subject: Interest expense
Question 1
Are you entitled to a deduction for the interest expenses on the reinstated investment loans for your rental properties?
Answer
Yes.
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
Year ended 30 June 2020
The scheme commenced on
1 July 2015
Relevant facts
On the xx Month 2015, your X investment loans on Y investment properties were paid out incorrectly by Bank X.
An administration error occurred when Bank X used the funds from the sale of your principle place of residence to payout your investment loans instead of it being made available to purchase your new residence.
You have not incurred additional principal or extra borrowing costs in relation to the new loans.
The loans have been reinstated to the amounts prior to the incorrect payouts as at xx Month 2015 and new loan accounts have been issued.
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 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.
A number of significant court decisions have determined that for an expense to be an allowable deduction:
• it must have the essential character of an outgoing incurred in gaining
• assessable income or, in other words, of an income-producing expense
• (Lunney v. FC of T; (1958) 100 CLR 478 (Lunney's case)),
• there must be a nexus between the outgoing and the assessable income so
• that the outgoing is incidental and relevant to the gaining of assessable
• income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and
• it is necessary to determine the connection between the particular outgoing
• and the operations or activities by which the taxpayer most directly gains or
• produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v.
• FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).
Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.
The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.
Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible.
Furthermore, interest on a new loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing.
Your situation can be viewed as similar to the tax treatment when a loan is refinanced; the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities.
The administration errors that occurred on behalf of Bank X did not break the nexus between the interest expense under the new loans and earning assessable income and therefore you can continue to claim the interest expense as a deduction on your investment properties.