Edited version of private advice

Authorisation Number: 1052227081956

Date of advice: 15 March 2024

Ruling

Subject: Interest deductions

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Person A and Person B (You) own two units. You own these units jointly.

Unit 1 is located in City A of State A.

Unit 2 is also located in City A of State A.

You signed a contract for disposal of Unit 1 several years ago. Settlement for Unit 1 was due to occur several months later.

You signed a contract for the purchase of Unit 2 a short time after signing the contract for disposal of Unit 1. Settlement for Unit 2 was scheduled to occur some months later.

When making the decision to purchase Unit 2, you structured the transactions to ensure that settlement of Unit 1 occurred before settlement for Unit 2.

However, due to issues with the purchaser obtaining funds for the purchase of Unit 1, settlement of Unit 1 was delayed and has yet to occur.

You obtained a bridging loan. Unit 1 and Unit 2 were both used as security to enable the bridging loan to be approved.

The contract of sale for Unit 1 was used to enable you to obtain sufficient loan funds to purchase Unit 2 plus pay the balance of any loan for Unit 1.

You held the bridging loan for a period of several months. At the completion of that time, you moved to a new loan with a lower rate of finance.

At the time of refinancing the bridging loan, there was a balance remaining on the loan for Unit 1. This balance was unchanged from when you acquired the bridging loan.

You have incurred interest expenses on the bridging loan.

You have incurred setup costs for the bridging loan.

You have incurred fees to refinance from the bridging loan to two lower interest loans.

Loan 1 is secured against Unit 1.

Loan 2 is secured against Unit 2.

You have rented out Unit 1 for several months and will continue to rent it out until it is sold.

You currently reside in Unit 2.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-25

Reasons for decision

Question 1

Summary

The full amount of interest you incurred on the bridging loan is not deductible 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. The exception to this is where the outgoings are of a capital, private or domestic nature.

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 outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. 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.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro(1926) 38 CLR 153, (1926) 32 ALR 339 (Munro's case) is the basic test for the deductibility of interest and looks at the application of the borrowed funds as the main criterion. 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.

Application to your circumstances

You took out the bridging loan to enable you to pay off the loan on Unit 1 and to purchase Unit 2. As all of the interest expense does not relate to the earning of assessable income, you cannot claim a deduction for the full amount of the interest expense.

Question 2

Summary

Some of the interest you incurred on the bridging loan is deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Paragraph 6 of Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities states:

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 T91 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 T99 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, where a loan relates to private purposes, no deduction is allowed.

Application to your circumstances

You can't claim interest on any part of the bridging loan used for private purposes from the time you took out the loan. As you made the decision to rent out Unit 1 in MM YYYY, you can claim deductions for interest from that point. That is the point at which you began to use Unit 1 to earn assessable income.

You should claim your deductions in accordance with your legal interest in the property.

Question 3

Summary

All of the borrowing expenses you incurred on the bridging loan are not deductible under section 25-25 of the ITAA 1997.

Detailed reasoning

Section 25-25 of the ITAA 1997 provides that you can deduct expenditure you incur for borrowing money, to the extent that you use the money for the purpose of producing assessable income. In most cases the deduction is spread over the period of the loan. You cannot deduct anything for an income year if you do not use the borrowed funds for the purpose of producing assessable income at all during that income year.

Section 25-25 of the ITAA 1997 contains the method for calculating the amount available as a deduction based on use of the borrowed funds.

Application to your circumstances

As you did not use all of the borrowed funds for the purpose of producing assessable income, you cannot claim a deduction for the full amount of the borrowing expenses.

Question 4

Summary

Some of the borrowing expenses you incurred on the bridging loan are deductible under section 25-25 of the ITAA 1997.

Detailed reasoning

As outlined in Question 3, you can deduct expenditure you incur for borrowing money, to the extent that you use the money for the purpose of producing assessable income.

Application to your circumstances

As you did not use any of the borrowed funds for the purpose of producing assessable income during the income year ending 30 June 20YY, you cannot claim any deductions for borrowing expenses during that period.

You commenced using Unit 1 to earn assessable income in MM YYYY. As a result, you can deduct borrowing expenses from that point on.

You will need to apportion the borrowing expenses to exclude the portion of borrowing expenses that relate to the loan for Unit 2.

You should claim your deductions in accordance with your legal interest in the property.

Question 5

Summary

The full amount of interest you incurred on Loan 1 is not deductible.

Detailed reasoning

As outlined in Question 1, 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. The exception to this is where the outgoings are of a capital, private or domestic nature.

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.

Application to your circumstances

You cannot claim a deduction for the full amount of interest incurred on Loan 1. The loan is a mixed purpose loan, with some of the funds being used to purchase Unit 2 and some of the funds being used to pay off the loan for Unit 1.

Although Loan 1 is secured against Unit 1, not all of the interest incurred on the borrowed funds is incurred in the course of producing assessable income.

Question 6

Summary

Some of the interest you incurred on Loan 1 is deductible.

Detailed reasoning

Application to your circumstances

Loan 1 is a mixed purpose loan, with some of the funds used to pay for an income producing asset and some of the funds used to purchase a non-income producing asset.

As a result, you will need to apportion your interest deductions in accordance with the percentage of the loan that relates to Unit 1.

You have advised that when you received the loan, the balance remaining on Unit 1's loan was $XX. Therefore, you should apportion your interest deductions so that you are only claiming a deduction for that percentage of the loan funds.

You should claim your deductions in accordance with your legal interest in the property.