Edited version of private advice

Authorisation Number: 1052302269094

Date of advice: 24 September 2024

Ruling

Subject: Deductions - interest expenses

Question

Are you entitled to a deduction for the interest on your refinanced investment loan for Property A?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

Person A and Person B (You) own a property (Property A). Property A is an investment property which you use to produce assessable income.

Person A previously owned a property (Property B).

Person A sold a property (Property B) several years ago.

Prior to that, Property B was an investment property which was used to produce assessable income.

Property B was an investment property which was also used to produce assessable income.

Loan A commenced in 20XX on Person A's purchase of Property B. In 20XX, You split Loan A into a part fixed loan (Loan B) and part variable (Loan C,).

Some of the loan funds were used to buy and later renovate Property B.

Some of the funds in one of the loans were used to cover the costs of renovating Property A.

You also had two other loans related to Property A which were used to buy the land and build the house along with other associated costs (Loans D and E).

All of the loans are in the name of Person A and Person B.

You decided to simplify your banking by combining the two loans related to Property A into one loan.

You did not realise that this may create a tax issue.

Settlement for Property B occurred on Date One.

Person A repaid Loan E on Date Two.

Person A repaid Loan D on Date Two.

Based on your expenditure for Property A since you commenced using it to earn assessable income, you made sure that the loan balance was reduced to the amount that would have been owing on Date Two if you had not amalgamated the loans.

You repaid Loan B on Date Three.

The total loan amount that remains on foot consists of expenditure related to Property A only.

Loan D was amalgamated into Loan C on Date Three.

Loan E was amalgamated into Loan C on Date Two.

The balance of Loan C was Amount A on Date Four.

You reduced Amount A on Date One so that it was equivalent to the total amount previously owing on your separate loans in relation to Property B.

From Date One, You will claim interest deductions in accordance with your ownership interest in Property A.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent they are incurred in gaining or producing assessable income.

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 Taxation Ruling TR 95/25 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 is the basic test for the deductibility of interest and looks at the application of the borrowed funds as the main criterion.

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.

Paragraph 42 of TR 95/25 addresses borrowings used to repay an existing loan. The paragraph states that interest on a new loan will be deductible if the new loan is used to repay an existing loan, which, at the time of the second borrowing, was being used in an assessable income producing activity or used in a business activity which is defined to include the production of assessable income (Roberts and Smith ATC at 4388; ATR at 504).

Application to your circumstances

You have amalgamated two loans relating to Property A into one loan for ease of use. The previous loans related to Property A which is used to produce assessable income.

You have ensured that the amount owing on the new loan is equivalent to the amount previously owing across the amalgamated loans at the date when the new loan was commenced.

You have repaid the other loans that related to Property A at the date of commencement of the new loan.

Therefore, any interest you incur on the loan is deductible as Property A is used for income producing purposes.