ATO ID 2001/79: Interest expense: Funds Borrowed
Date of decision: 9 January 1998
Business line: Public Groups and International

Issue
Whether interest on funds borrowed to acquire the share of the taxpayer's spouse (the spouse) in a property, to be kept for investment purposes is deductible.

Decision
The interest is deductible under section 8-1 to the extent that the borrowed funds are used for the purposes of producing assessable income.

Facts
The taxpayer and the taxpayer's spouse own a property as joint tenants. The taxpayer has obtained an independent valuation of the property. The taxpayer intends to borrow an amount of money equal to one half of the value of the property to fund the purchase of the spouse's half share in the property. After the acquisition of the spouse's half share the taxpayer intends to let the property to tenants.

Reasons for decision
Summary: Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in FC of T v Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest incurred will be deductible to the extent that the property is used to produce assessable income.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: FC of T v Munro (1926) 38 CLR 153
Subject references: Arms length transactions Associated persons Disposal of real estate Negative gearing Non arms length transactions Principal residence Rental expenses Rental property Rental property loan interest expenses Tax planning, avoidance and evasion