Edited version of your written advice

Authorisation Number: 1051224739092

Date of advice: 12 May 2017

Ruling

Subject: Deductibility of interest on a repaid and then redrawn loan

Question

Are you entitled to claim a deduction of the full interest charged on your property loan where the loan was repaid and then redrawn for non-income producing purposes?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commences on:

1 July 2015

Relevant facts and circumstances

You are the joint owners of a rental property in Australia.

You have a joint Principal and Interest loan for the rental property (property loan).

You have a deposit/offset account (offset account) which is linked to the property loan.

You transferred an amount from the offset account to the property loan account.

You redrew two amounts from your property loan account and deposited them in your offset account.

You redrew a further amount from your property loan to your offset account on the advice of your tax agent. You did this to restore the property loan and offset account to the point before the original deposit to your property loan from your offset account.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

In your case, the funds withdrawn under the redraw facility were for private, non-income producing purposes. You are therefore not entitled to a deduction for the interest charged on the amounts withdrawn from your income producing loan under section 8-1 of the ITAA 1997.

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.

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.

Taxation Ruling 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 borrowing and as such, the purpose or use of these drawings is relevant.

In accordance with TR 2000/2, interest is fully deductible where funds drawn down on an investment continue to be used exclusively for an income producing purpose. Paragraph 28 of TR 2000/2 discusses the deductibility of interest on a further borrowing of money under a redraw facility, which depends upon the use to which the redrawn funds are put. Where the original borrowing is for income producing purposes and the redrawn funds are wholly or partly used for non-income producing purposes, that part of the accrued interest attributable to the redrawn funds used for non-income producing purposes is not deductible.

In your case, depositing personal funds from your offset account in your property loan is considered a permanent reduction of the loan. Since you withdrew these amounts and deposited them in your offset account, you used them for private, non-income producing purposes. You are not entitled to a deduction for the portion of interest applicable to the redrawn amount.

However, you did this as all you could see was you would be charged the same amount of interest against the property loan. Your understanding was this was irrespective of whether this came about by reducing the property loan directly or by the bank charging interest on the difference between the property loan and your offset account. You misunderstood the impact of re-drawing funds from your property loan and not applying them to an income producing purpose.

However, the Commissioner does not have any discretion to allow you to treat the new borrowings as tax deductible as you applied those new borrowings to a non-deductible purpose by depositing them in your offset account.

Therefore, as the redraws were equivalent to the repayment amount of the loan; interest accrued is now attributable to redrawn funds used for non-income purposes is no longer deductible under section 8-1 of the ITAA 1997.