Edited version of your written advice

Authorisation Number: 1013035036628

Date of advice: 17 June 2016

Ruling

Subject: Foreign Income Tax Offset

Question and answer

1. If a refinance of a mixed purpose loan involves the creation of a new loan for an amount equal to the income producing purposes proportion of the existing loan balance and the existing loan balance is reduced by this amount, will the existing loan become a loan exclusively for non-income producing purposes?

No.

2. When a property changes from income producing to non-income producing and has an existing loan with a redraw facility that was used to finance the acquisition of the property and used for other non-income purposes, do you use the calculation principles expressed in TR 2000/2 to calculate the proportion of the existing loan which is incurred in earning assessable income?

Yes.

3. If other sources of funding are used to directly pay for expenses relating to income producing purposes' which are subsequently paid for at later dates using loan redraws, is this accepted as a use of loaned funds for income producing purposes?

No


4.  if so, when is it considered that the loan for income, producing purposes is effective?

Not applicable

This ruling applies for the following periods:

Year ending 30 June 2016

The scheme commenced on:

1 July 2015

Relevant facts and circumstances

You have an existing loan which was for income producing and non-income producing purposes.

You have taken out a second loan which you have used to partially repay the existing loan.

The bank could not offer you the same redraw facility.

The new loan does not have the facility to make direct payments from the loan account. Withdrawn amounts from the loan account are required to be deposited into another account.

You pay bills relating to the rental property by doing one of two things:

1. Invoices are paid by credit card, which is used for both income and non-income producing transactions, and then you withdraw the relevant amount for income producing expenses from the new loan.

2. Funds are withdrawn from the loan into a savings account, which is used or both income and non-income producing transactions, and the invoices are paid out of that account.

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.

Accordingly, it follows that if a loan is used for non-income producing purposes and income producing purposes from which income is to be derived, the interest incurred on the loan will be apportioned between the purposes and the portion for income producing purposes will be deductible. 

Further, 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.

That is, 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.

Your refinanced loan will not break the nexus of the loan being for two purposes income producing and non-income producing.

Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities discusses the deductibility of interest on drawings against a line of credit or redraw facility. It is considered that a repayment to a loan account is a permanent reduction to the debt and any redrawn funds constitute new lending. Where a loan is for mixed purposes, a deduction is only allowed for the portion of the interest which relates to an income producing purpose.

Paragraphs 12 to 21 of TR 2000/2 set out a method of apportioning interest on mixed purpose accounts.

Where interest on borrowed money generally accrues daily, we accept that it would be unnecessarily onerous to require a manual daily apportionment calculation. We accept that the interest accrued in a month is deductible where it is calculated using an apportionment approach based on the average outstanding principal used that month for income producing purposes. The deductible portion of interest accruing in each month may be calculated as follows:

total interest accrued for the month x deductible interest percentage figure

The deductible interest percentage figure is calculated as follows:

((A + B) / (C + D)) x 100

where

A = opening balance (beginning of month) of outstanding principal used for income producing purposes,

B = closing balance (end of month) of outstanding principal used for income producing purposes,

C = opening balance of total outstanding principal and

D = closing balance of total outstanding principal.

Note: the closing balance for one month is the opening balance for the next month.

You cannot choose to notionally allocate the repayments to a particular portion of the total debt, e.g., the non-income producing portion.

Consequently a calculation must be made taking into account any repayments you have made on the loan as these are considered to be permanent reductions of the loan. The calculation must also take into account the purpose of any redraws you have made on the loan as any private redraws will affect the deductibility of the interest incurred. You will be entitled to only the portion of interest on the remaining balance of the original loan calculated using the above formula.

All transactions both deposits and withdrawn amounts must be separately identify or characterise so that you can determine which is for income and non-income producing purposes when using the credit card account and the savings account in order to calculate the apportioned interest accurately.