Edited version of private advice

Authorisation Number: 1052126986910

Date of advice: 23 June 2023

Ruling

Subject: Deduction - penalty interest for early payout on investment loan

Question

Is the "economic cost" charged by the lender for breaking the fixed-rate mortgage on a residential investment property deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), or any other section of that Act?

Answer

Yes. The economic cost you were charged is a form of penalty interest. In your circumstance the advantage sought by breaking the fixed rate mortgage early on a residential investment loan and incurring penalty interest is future interest savings from a lower interest rate. Where the advantage sought is release from the recurrent liability to pay interest which would have been deductible, the penalty interest payable is revenue in character. Penalty interest of a revenue character is deductible under section 8-1 of the ITAA 1997.

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.

A penalty interest payment arising from early repayment of a loan will generally be deductible under section 8-1 of the ITAA 1997 where:

•         the loan moneys were borrowed for the purpose of gaining or producing assessable income or for use in a business carried on for that purpose, and

•         the payment was made to rid the taxpayer of a recurring obligation to pay interest on the loan, where such interest would itself have been deductible if incurred.

This ruling applies for the following period:

Year ended 30 June 2021

The scheme commenced on:

1 July 2020

Relevant facts and circumstances

You own a rental property as joint tenants.

You had a fixed loan for the property.

After settlement you lived in the property for several months, after which it was made available to rent. During the period you lived there the property was not available for rent.

You had a fixed loan for the rental property.

After you moved out of the property it was immediately available for rent from that date onwards.

You refinanced the loan at a lower interest rate. The property remained tenanted after you refinanced.

The fixed loan rate was paid out in full early when you refinanced.

The lender charged you an "economic cost" for paying the fixed loan out in full early.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1