Edited version of private advice

Authorisation Number: 1052087880071

Date of advice: 28 February 2023

Ruling

Subject: Interest deductions on an investment property

Question

Can I claim interest deductions for the property at Address 1 under section 8-1 of the Income Tax Assessment Act 1997?

Answer

No.

This ruling applies for the following period:

Year ending XX June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You and your spouse purchased "the investment property" at XXXXX in 20XX for $XX0,000.

No interest was claimed against the investment property as you were unable to secure finance due to the property only being XX square metres, which did not meet the banking criteria.

The investment property was a retail shop and was rented out for $XXXX per week.

In 20XX you separated from your spouse and in 20XX the settlement for your divorce was finalised. The investment property was transferred solely into your name.

In 20XX you took out a home loan with XXXX for $XXX,000 to purchase property at Address 2.

Once the XXXX loan was in place, the rental income earnt from your investment property was paid directly into the XXXX loan account by your tenant.

No change was made to the managing of the investment property.

You sold the investment property in December 20XX for $XXX,000.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Reasons for decision

Can you claim interest deductions for the property at Address 1 under section 8-1 of the Income Tax Assessment Act 1997?

Summary

No. We do not consider there is nexus between incurring the interest expense on Loan with XXXX to gaining assessable rental income on the investment property. Incurring the interest expense is considered one step removed from earning rental income. Therefore, the interest expense is not an allowable deduction 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.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

•         it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478),

•         there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

•         it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Taxation Ruling TR 95/25 Income tax: deductions for interest under subsection 51(1) of the Income Tax Assessment Act 1936 following FC of T v. Roberts; FC of T v. Smith provides the Commissioner's view regarding the deductibility of interest expenses. As broadly outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income (paragraph 3(a) and paragraph 21). 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 (paragraph 3(b)).

Taxation Ruling 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities states:

6. The deductibility of interest is typically determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put (Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613, FC of T v. Energy Resources of Australia Limited 96 ATC 4536; (1996) 33 ATR 52, and Steele v. FC of T 99 ATC 4242; (1999) 41 ATR 139 (Steele)).

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, pursuant to section 8-1(2)(b) of the ITAA 1997 you cannot deduct a loss or outgoing under this section to the extent that it is a loss or outgoing of a private nature. Expenditure that is essentially of a private or domestic nature is not deductible on the basis that it cannot satisfy either of the two positive limbs of section 8-1 of the ITAA 1997.

Having regard to all your circumstances, we do not consider there is nexus between incurring the interest expense on Loan with XXXX to gaining assessable rental income on the investment property. Incurring the interest expense is considered one step removed from earning rental income. Therefore, the interest expense is not an allowable deduction under section 8-1 of the ITAA 1997.