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Edited version of your written advice
Authorisation Number: 1012980506130
Date of advice: 4 March 2016
Ruling
Subject: Rental property interest expenses
Question
Are you entitled to claim a deduction for interest incurred on amounts redrawn from a loan which deposited into an offset deposit account?
Answer
No
This ruling applies for the following periods:
Year ended 30 June 2016
The scheme commences on:
1 July 2015
Relevant facts and circumstances
You commenced an interest-only loan to purchase an income producing investment property. You subsequently paid amounts off the loan to reduce the amount of interest incurred, believing that an offset and a redraw facility had the same effect.
You subsequently discovered you do not have an offset facility.
You wish to redraw funds from the original loan to restore the original balance and take advantage of the offset facility now attached to the loan.
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, or relate to the earning of exempt income.
Taxation Ruling TR 95/25 deals with the general principles governing deductibility of interest under section 8-1 of the ITAA 1997.
To establish that there is a sufficient connection between incurring an interest expense and the gaining or producing of assessable income, regard must be given to all the circumstances including 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 to the application of the borrowed funds as the main criteria.
Taxation Ruling TR 2000/2 provides the ATO view on the deductibility of interest on money drawn down on a loan with redraw facilities. In this ruling the Commissioner considers a redraw from a loan account, is a separate borrowing. Therefore, the deductibility of the interest on that separate borrowing depends on whether the interest is incurred in gaining or producing assessable income. To the extent borrowings are used for income producing purposes, that part of the accrued interest attributable to those borrowings is deductible
In your case, you are redrawing the funds merely to "top up" your deposit account to enable the operation of an offset account. The new loans are therefore not being used for an income-producing purpose. In effect, you cannot purchase an income producing asset twice - your original loan was used to purchase an income producing property, and you subsequently made repayments that reduced the balance upon which the interest was calculated on. If you subsequently redraw these amounts, you can only deduct the additional interest if the funds are put to a new income producing purpose.
Depositing funds into an account to enable an offset facility is not considered to be a new income producing purpose. You therefore cannot claim any additional interest expenses beyond those incurred on the original purchase of the income producing property.