Private ruling: Interest Deductions
Date of advice: 12 December 2017
Published: April 2018
Ruling period: Year ended 30 June 2018 | Year ended 30 June 2019 | Year ended 30 June 2020 | Year ended 30 June 2021
Date scheme commenced: 1 July 2017

Ruling: Q1: Where borrowed funds have been drawn down from an interest only mortgage loan into an offset account, are you entitled to a deduction for the interest expenses incurred after the funds are withdrawn from the offset account and used for income producing purposes? | A1: Yes | Q2: Is the deductibility of interest expenses affected by the amount of time that has elapsed between when the funds are initially borrowed and when they are actually used? | A2: No

Relevant facts and circumstances: You want to borrow funds for investment purposes. You will do this by taking out an interest only mortgage loan, with an offset account attached, against the available equity in a residential property that you own. You want to draw down the borrowed funds from the mortgage loan into the attached offset account and leave the funds unused until you decide on the appropriate nature, timing and size of your investment purchases. Until the borrowed funds in the offset account are used for investment purposes there will be no personal funds deposited into the offset account and the funds will not be used for any non-investment purposes. There will be no interest expenses incurred on the borrowed funds in the offset account while they remain unused.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision: Summary: You will be entitled to a deduction for the interest expenses incurred on the borrowed funds when they are used for income producing purposes. The time between when the funds are borrowed and when they are used will not affect the deductibility of the interest expenses that are incurred after the funds are used for income producing purposes. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the Income Tax Assessment Act 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, or relate to the earning of exempt income. Taxation Ruling TR 95/25 provides that the deductibility of interest is determined by the use for which the borrowed money is put. The 'use' test, established in Federal Commissioner of Taxation 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 criteria. Where borrowed funds are used for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income. It is not necessary that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred. Taxation Ruling TR 2004/4 in considering the decision of the High Court in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income where: ● the interest is not incurred too soon, is not preliminary to the income earning activities and is not a prelude to those activities ● the interest is not private or domestic ● the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost ● the interest is incurred with one end in view, the gaining or producing of assessable income, and ● continuing efforts are undertaken in pursuit of that end. It is therefore generally accepted that ordinary interest incurred on funds borrowed to acquire an income producing asset is an allowable deduction. In your case, you will take out a loan with an offset account and deposit all the funds borrowed into the offset account until you find appropriate investments to purchase. Before the funds are used for investment purposes, you will not incur any interest expenses on the loan due to the funds being in the offset account. It is considered that under this arrangement, you will be entitled to a deduction for the interest expenses incurred once the borrowed funds are used for income producing purposes. The amount of time between when the funds are borrowed and when they are used for income producing purposes has no impact on the deductibility of the interest expenses incurred after the funds are used for income producing purposes.

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