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Authorisation Number: 1051297447125

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Date of advice: 20 October 2017

Ruling

Subject: Loan interest

Question

Are you entitled to a deduction for the interest on the remainder of an investment loan after the property was sold?

Answer

Yes.

This ruling applies for the following periods

Year ending 30 June 2017

The scheme commenced on

1 July 2020

Relevant facts

You were the sole owner of two rental properties and had one loan for both properties.

The proportion of the loan funding for each property was different.

You claimed deductions for the loan interest on the two properties in the proportion of the funding for each property.

One property was sold

You applied an amount from the property sale proceeds to the loan which was slightly more than the amount outstanding on the property which was sold.

The amount deposited was not enough to repay the loan and there is still a loan balance relating to the rental properties.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Taxation Ruling TR 2004/4

Reasons for decision

Summary

The nexus between the expense and the income earning activity has not been broken; therefore a deduction is allowable for the interest expense.

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.

Interest expenses are generally deductible under section 8-1 of the ITAA 1997 to the extent that it is incurred in relation to funds used for an income producing purpose.

The Commissioner’s view on whether interest deductions are allowable after the cessation of the relevant income producing activity is outlined in Taxation Ruling TR 2004/4.

TR 2004/4 considers the implications of the Full Federal Court decisions in Federal Commissioner of Taxation v. Brown 99 ATC 4600; (1999) 43 ATR 1 (Browns case) and Federal Commissioner of Taxation v. Jones 2002 ATC 4135; (2002) 49 ATR 188 (Jones case).

In Brown’s case, the taxpayer partners borrowed to acquire a delicatessen. After a number of years of trading, the business was sold at a loss. The proceeds of the disposal were made over to the bank but were insufficient to satisfy the liability fully. There was no entitlement under the relevant loan agreement to repay the loan prior to its term without prior agreement of the bank.

In Jones case, the taxpayer, together with her husband, borrowed money to fund a trucking and equipment hire business. After her husband's death, Mrs Jones sold the assets of the business. The proceeds (plus other amounts on hand) were insufficient to pay out the loan and she was unable to fully repay the loan.

Brown and Jones cases accordingly demonstrate that the occasion of interest expenditure can be found in the relevant income earning activities even where those activities are now defunct and all the borrowings (or assets representing those funds) are lost.

Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgment about the nexus between the outgoing and the income earning activities.

If the taxpayer:

● keeps the loan on foot for reasons unassociated with the former income earning activities; or

● makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred,

the nexus between the outgoings of interest and the relevant income earning activities will be broken.

In your case, the funds from the sale of the property that you applied to the combined loan were insufficient to pay out the loan in its entirety.

The amount from the sale which you applied to the combined loan was slightly greater than the percentage of the combined loan which related to the sold property.

Therefore, the loan was kept on foot for reasons directly related to the income earning activities and the nexus between the interest expense and the relevant income earning activity has not been broken. As a result, the interest expense is an allowable deduction under section 8-1 of the ITAA 1997.

You may continue to claim a deduction for the loan interest on the two properties in the proportion of the funding for each property, even though one property has been sold.

Interest on the combined loan will remain deductible as long as the nexus between the interest expense and the relevant income producing activity is not broken.

The deduction for the proportion of the interest relating to the sold property may continue to be reported on the rental property schedule as for the sold property.