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Edited version of your written advice
Authorisation Number: 1013107546808
Date of advice: 13 October 2016
Ruling
Subject: Compound interest expense
Question
Are you entitled to a deduction for your portion of the compound interest expenses on your line of credit account being used only for your rental properties?
Answer
Yes.
This ruling applies for the following period
Year ended 30 June 2017
The scheme commenced on
1 July 2016
Relevant facts
You and your spouse own investment properties. You are currently in the process of purchasing another investment property.
You are setting up a new line of credit facility to fund all costs for your current investment properties and the new investment property. The line of credit account will be in joint names. The line of credit account will not be used for private purposes.
The interest component from the line of credit account will compound.
All your investment properties are rented at market rates through real estate agents.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasons for decision
Interest expenses
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 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith 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. However, where a loan relates to private purpose, no deduction is allowed.
Taxation Determination TD 2008/27 Income tax: is the deductibility of compound interest determined according to the same principles as the deductibility of other interest? discusses compound interest. As outlined in TD 2008/27, where a loan is used solely for income producing purposes, any compound interest incurred in relation to the loan is also generally deductible.
Line of credit facilities
Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities.
The ruling establishes drawing any excess or available funds from the loan is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put.
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.
In your case your line of credit account will be used solely for your investment properties.
As your line of credit account is being used only for your investment property expenses, the associated interest and compound interest incurred is an allowable deduction.
Please note that co-owners of a rental property divide the income and expenses for the rental property in line with their legal interest in the property (Taxation Ruling TR 93/32). Therefore you are only entitled to a deduction of the relevant interest expenses according to your legal title in the properties.