Edited version of your written advice

Authorisation Number: 1012929071794

Date of advice: 16 December 2015

Ruling

Subject: Rental interest expense

Question

Is the interest on a redraw amount from an investment loan deductible where the redraw amount is used for private purposes?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You currently own a rental property with a balance outstanding on your loan.

You are intending to refinance your loan and include a redraw facility.

You have inherited an amount that you intend to pay towards your loan.

You intend to withdraw the amount in the future to use for private purposes.

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.

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.

In your situation, the deposit to your loan with a redraw facility is considered a permanent reduction or repayment to the loan. This will reduce the balance owing and will reduce the amount of interest incurred. Should the money be withdrawn from the account, it will be considered to be a redraw in relation to the loan.

The Commissioner regards the redraw as a separate instance of borrowing to the original loan. His rationale is explained in paragraphs 39-43 of Taxation Ruling TR 2000/2. He does not view the extra repayments that allow the redraw to occur, as a debt due by the lender to the borrower (you). He views the loan agreement as giving the borrower a right (subject to restrictions in some cases) to borrow a further amount up to the balance of the loan debt that would have been outstanding if the minimum loan repayments required under the loan had been made. The extra repayments have been used to discharge part of the loan and the subsequent redraw is funded by a subsequent increasing of the overall loan. The funds used to make extra repayments simply cease to exist as an asset of the borrower after being used to discharge part of the loan debt. The extra repayments do not create a debt payable by the lender to the borrower and are not an asset of the borrower after they have been used to discharge part of the loan debt.

At paragraph 22 of Taxation Ruling TR 2000/2 the Commissioner states that the deductibility of interest on a further borrowing of money under a redraw facility depends on the use to which the redrawn funds are put. If this is for a non-income producing purpose then the interest on the redraw amount is not deductible.

Where a person uses the redrawn funds for different purposes, then the loan account becomes a mixed purpose account. In a mixed purpose loan, the interest must be apportioned between the income producing and non-income producing purposes. The part of the accrued interest attributable to the funds used for private purposes is not deductible.

You intend to use the redraw facility on your loan for private purposes. Accordingly, the interest you incur on the redrawn amount will not be an allowable deduction.