Edited version of your written advice

Authorisation Number: 1051179309906

Date of advice: 10 January 2017

Ruling

Subject: Interest deductions - investment property - home loan - redraws - re-financing

Question 1:

Can you and your spouse claim 100% (50% each) of your interest deductions on your investment property known as Y?

Answer:

Yes.

Question 2:

Are you and your spouse entitled to a deduction for your share (50% each) of interest on redrawn funds (from the loan known as the Z mortgage) that will be used to fund the purchase of your new private residence?

Answer:

No.

Question 3:

Are you and your spouse entitled to a deduction for the full amount of interest you both incur (50% each) on a loan used to acquire an investment property where you withdraw funds from your offset account for non-income producing purposes?

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 commences on:

29 June 2009

Relevant facts and circumstances

X property

You and your spouse acquired a property (X). This property was your main residence from sometime in 2005 until early last year. You had a loan balance of a certain amount remaining when the property was sold. You made a profit from the sale of the property.

Z property

You and your spouse acquired a rental property known as Z a few years ago and had a mortgage known as Z for an amount similar to the purchase price. This property was rented as an investment property until the tenants vacated the property. This property became your main residence after you vacated the property know as X.

You had an investment, interest only loan for the Z property with a certain financial institution (A). A few years ago you changed the loan type with A from an investment interest only loan (fixed product) to a variable loan. This required you to make a mandatory payment of a certain amount. This brought the A loan balance down.

With the profits from the sale of the X property you made three large separate deposits on different days into your Z property loan.

This reduced the Z loan substantially.

About a week later you made a re-draw of a large amount from the Z loan and deposited the amount into an everyday transactor account. This increased the Z loan debt substantially.

Shortly after you transferred the large amount from the everyday transactor account back to the Z loan. This reduced the loan balance substantially.

Later you deposited a smaller amount into the Z loan reducing the loan balance.

Later you deposited another small amount into the Z loan reducing the loan balance.

Later you made a loan re-draw of a large amount from the Z loan and deposited the amount back to your everyday transactor account. This increased the Z loan debt substantially.

A month or so later the Z loan balance of the larger amount was paid out with a re-financed bank loan with a new financial institution for a residential owner occupied loan debt.

The loan with the new financial institution is for the larger amount.

You have said that you never intended to make these payments (the profits from the sale of the X property) into the Z loan as you never intended to move into the Z property on a long term basis. You only intended that this property be your main residence for a temporary time.

You have also said that you were too scared to use BPAY and that this was the only secure way to transfer your funds from your previous financial institution to the new financial institution. You realised that this understanding was incorrect and that long term you had never meant to pay down the loan.

Y property

You and your spouse purchased a property, (a house and land package) known as Y a number of years ago. You borrowed almost all of the money to enable the purchase. This property has been a rental property since the house was constructed.

Last year either you or your spouse deposited a large amount the Y property loan account this reduced the loan balance substantially.

Later on the same day, either you or your spouse made a re-draw of exactly the same amount from the Y property loan and deposited the amount into your everyday transactor account. This returned the loan balance to the original amount.

You have said that this was an accidental payment caused by using the banking application on your spouse's iPhone 6, it happened by pushing very sensitive buttons. A few moments later when you realised the error you moved the money out again, immediately on the same day.

Mortgage Offset account

For the purposes of this private binding ruling and answering your question relating to Mortgage Offset accounts the following will happen:

You will have a mortgage for an investment property and an offset account against that mortgage.

The offset account impacts on the interest incurred on the mortgage in that when you have money deposited in the offset account it will reduce the amount of interest charged on the mortgage loan.

From time to time you may withdraw money from the offset account only to be used for personal purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Anti-avoidance rules

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

You and your spouse will be able to claim 100% (50% each) of your interest deductions on your investment property known as Y.

It is accepted that the one off deposit of a large amount into the Y property loan was an error made by you or your spouse selecting the wrong account while using the banking application on your spouse's iPhone 6. This is supported by the fact that the money was then taken out immediately from the Y property loan account and deposited into the correct account on the same day.

Question 2

Summary

You and your spouse are not entitled to a deduction for your share (50% each) of interest on redrawn funds (from the loan known as the Z mortgage) that will be used to fund the purchase of your new private residence.

Detailed reasoning

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.

Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. Interest incurred on a loan relating to a rental property will generally be deductible.

Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities (TR 2000/2) examines the treatment and consequences of payments to loans in excess of the required amount and the subsequent redrawing of these funds.

It is considered that a repayment to a loan account in excess of the required amount is a permanent reduction to this debt. Repayments of an amount to a loan do not create a debt due to the borrower, but simply allows the borrower to then draw funds from the loan to an agreed limit. These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant.

Redraws may then result in circumstances where a loan contains mixed purposes. In these instances you are entitled to a deduction for the portion of the interest of the loan which relates to an income producing purpose. Apportionment of the interest between the mixed purposes may be required. Paragraphs 19-20 of TR 2000/2 contain formulas which can be used to calculate the income producing portion of interest.

In Domjan v Commissioner of Taxation 2004 ATC 2204; 56 ATR 1235, the AAT confirmed the view taken by the Commissioner in TR 2000/2. In this case, the taxpayer repaid money into their investment loan account and then used the funds available in the redraw facility to pay for various personal and investment expenses. The question to be answered by the tribunal was whether the whole of the interest incurred on the loan was a deductible expense.

The taxpayer argued that the loan was 'a chose in action with a right to access funds in the redraw facility as if it was a separate sub-account in the loan facility'. The taxpayer further argued they were merely re-accessing private funds when they redrew and that the loan was still only attributable to their investment activities, making the interest deductible. However, the Tribunal rejected this argument.

The Tribunal found that amounts redrawn from this type of loan facility constituted the new borrowing of funds and that consequently, the interest payable on the amounts redrawn for private use was not deductible.

In your situation, making the payments to your Z mortgage is considered a permanent reduction to the loan. The nature of the redraws you have made are characterised by the use to which they have been put, that is, to fund the purchase of your future new private home.

Accordingly the interest relating to these redrawn amounts is of a private nature and is not deductible.

We have noted that during the time of your deposits, redraws and re-financing of your Z mortgage that you were at first confused by the instructions given to you by your new financial institution to facilitate the transfer of your loans and savings from your old financial institution to the your financial institution. We have also noted that it was not your intention to pay down the Z loan on a long term basis and that you expected your move into the Z property as a main residence to be temporary whilst you are finding your dream home. However the Commissioner has no discretion in this matter to allow an interest deduction when the redrawn funds will be used for a non-income producing purpose.

Question 3

Mortgage account with a mortgage offset account

Section 8-1 of the 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

Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset, the interest on this borrowing is considered to be incurred in the course of producing assessable income. With regards to borrowings relating to property, the interest will be deductible to the extent that the property is used to produce assessable income.

Taxation Ruling TR 93/6 Income tax and fringe benefits tax: loan account offset arrangements (TR 93/6) outlines the Commissioner's view on 'interest offset arrangements' which are used to reduce the interest payable on a taxpayer's loan account. TR 93/6 provides that an acceptable loan account offset arrangement with dual accounts operates as follows:  

● There are two accounts a loan account and a deposit account. It is accepted that where the deposit account is a sub-account, it will be treated as a separate account.

● No interest is received on the deposit account.

● The interest on your loan can only be reduced to the extent of the amount of interest which would have been charged on the loan amount equal to the balance of your deposit account. For example, you have a loan of $250,000 and a credit balance in your deposit account of $50,000. You can only obtain a maximum reduction of interest as if the balance of your loan was $200,000 (reduced by the $50,000 balance of your deposit account).

A taxpayer with an acceptable loan account offset arrangement with dual accounts is entitled to claim a deduction for the full amount of interest incurred on the loan account whilst the loan is used wholly for income producing purposes.

This will remain the case even if funds are withdrawn from the deposit account and used for non-income producing purposes. Depositing funds into the deposit account will decrease the interest payable on the loan account but will not decrease the balance of the loan account. Withdrawing funds from the deposit account will increase the interest payable on the loan account but will not increase the balance of the loan account.

Therefore if you have a loan used wholly for income producing purposes, you are entitled to a deduction for the full amount of the interest incurred on the loan regardless of whether amounts are withdrawn from the attached offset (deposit) accounts for personal use.