Private ruling: Main residence exemption, absence choice and deductibility of interest on a loan for an income earning asset
Date of advice: 18 July 2017
Published: November 2017
Ruling period: Year ending 2017
Date scheme commenced: 1 June 2016

Ruling: Q1: Will you be able to apply the absence rule under section 118-145 of the Income Tax Assessment Act 1997 (ITAA 1997) and treat dwelling M as your main residence? | A1: No | Q2: Will you be eligible to claim deductions for the whole of the interest payments you make in relation to loans you have taken out? | A2: No

Relevant facts and circumstances: You and your then spouse jointly acquired an ownership interest in dwelling M. You and your then spouse continued living in dwelling M from the date of acquisition until about X years ago when you both relocated to a rental property whilst you arranged for dwelling M to be demolished and a new dwelling built on the site. Shortly afterward, title of dwelling M was transferred into your spouse’s name, leaving your spouse with a 100% ownership interest in dwelling M. No consideration was received by you on the transfer of your XX% ownership interest in the dwelling M to your spouse. You paid stamp duty connected with the transfer of your XX% ownership interest in dwelling M to your spouse. You continued to pay all utilitiy costs and expenses associated with dwelling M from the date of acquisition as a joint owner. The mortgages for dwelling M were in your name only and you continued to make repayments to these loans whilst not having an ownership interest in dwelling M until your former spouse paid the mortgages as part of the marriage settlement agreement. Some months later, you and your then spouse separated. From the time of separation and for the next few months, your children continued to reside at a rental home whilst dwelling M was being built. During this period, you and your spouse moved into and out of rental properties to share parental responsibilities. After the completion of the construction of dwelling M, the children relocated to dwelling M and you and your spouse swapped each alternative week between the dwelling M and other accommodation. When not residing in dwelling M, you resided at a rental property each fortnight to spend time with your children. Later, your spouse resided with the children full time in dwelling M, whilst you moved into a rental property. You continued to live in the rental property, with the children spending one week with you and then one week with your former spouse at dwelling M. You initially planned to sell dwelling M by auction and following the auction, you received an offer. Instead of selling dwelling M, you negotiated with your spouse to purchase dwelling M. You and your spouse entered into an agreement in relation to the division of assets owned by you and your spouse under the provisions of the Relevant Law Act. You took out X interest only loans in your name totalling $X,000,000. This money was used only for the purpose of making the payment described in the Relevant Order. You are incurring interest expenses on these loans. The amount needed to discharge the mortgages to dwelling M was $Y,000.000 and your spouse discharged these mortgages following the transfer of the settlement sum to your spouse as part of the Relevant Law consent orders. The repayment made by your spouse to a third party relates to a loan made by the third party to cover the mortgage costs of dwelling M and other incidental expenses during recent periods. The balance of the payment your spouse will make to you as part of the consent orders was $Z00,000 and will cover your general living expenses. The Minute of the consent orders state that the value of the matrimonial asset pool is approximately $P,000,000 based on the value of assets and liabilities. Some of the obligations stipulated in the consent orders include in consideration of the payment you make to your spouse under the consent orders, your spouse transferring interests in various entities to you. In the Relevant Court orders it was agreed that a value of $Q,000,000 be attributable to the combined value of shareholdings and economic interests held by you and other associated entities. After the auction, dwelling M was rented out, with your former spouse deriving weekly rental income for a X month period. You then acquired titled to dwelling M. You continued to live in a rental property and rent out dwelling M.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 118-145. | Income Tax Assessment Act 1997 Section 118-150 | Income Tax Assessment Act 1997 Section 118-175.

Reasons for decision: Summary: You cannot choose to treat dwelling M as your main residence when you last became the owner under the absence rule, as you have not established dwelling M as your main residence at any time after that date. Your relationship with dwelling M prior to becoming the owner (the last time) is disregarded in reaching this conclusion. | Detailed Reasoning - Capital gain tax: You make a capital gain or capital loss when a capital gain tax (CGT) event happens to a CGT asset, such as selling your dwelling. Generally, you can disregard a capital gain or capital loss you make on the sale of a dwelling if: ● The dwelling was your main residence for the whole of the ownership period. ● You did not earn assessable income from the dwelling while you lived there. ● You did not choose to treat any other dwelling as your main residence during any part of your ownership period; and ● The adjacent land sold with the dwelling is less than two hectares in size. | Detailed Reasoning - Absences: Section 118-145 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you can choose to continue to treat a dwelling as your main residence after it ceases to be your main residence. If you use the part of the dwelling that was your main residence for the purpose of producing assessable income, the maximum period that you can treat it as your main residence under this section while you use it for that purpose is six years. You are entitled to another maximum period of six years each time the dwelling again becomes and ceases to be your main residence. Section 118-145 of the ITAA 1997 is a re-written version of the former subsection 160ZZQ(11) of the Income Tax Assessment Act 1936 (ITAA 1936). Section 1-3 of the ITAA 1997 states that the re-written version is not considered to be different to the original provision just because a different form of words were used if the re-written provision appears to be expressing the same idea in a clearer or simpler style. Former subsection 160ZZQ(11) of the ITAA 1936 limits the right to choose to use the absence choice to situations where: 'a dwelling owned by a taxpayer ceases to be the sole or principal residence of the taxpayer’. The text of Chapter 2.12 of the Explanatory Memorandum to the Tax Law Improvement Bill (No. 1) 1998 indicates that no change to this aspect of the absence choice was intended in the re-write of this provision. You have not identified or nominated another reason why dwelling M could be your main residence from late 20XY, even for a short period. Therefore, there is no basis on which you can access the absence choice during your current ownership period. | Summary: The interest payments you make on the loans of $X,000.000 you have taken out are only deductible to the extent they relate to the amount of $B,000,000 that you were required to pay to your spouse in return for your spouse transferring dwelling M to you in accordance with the Relevant Court Consent Orders. | Detailed Reasoning - Detailed reasoning: 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. Taxation Ruling TR 95/25 sets out in detail the ATO view on the deductibility of interest expenses. In summary, for interest expenses to be deductible under section 8-1 of the ITAA 1997, the general principles to be met include: ● the interest expense must have a sufficient connection with the rental income producing activity(ies) of the taxpayer and not be of a capital, private or domestic nature; ● the interest on money borrowed must be characterised by reference to the use to which the borrowed funds have been put by the taxpayer; ● the interest will not be deductible to the extent to which it is private or domestic in nature. Therefore, a deduction is allowed for the interest on a loan where the loan is used to acquire an income producing asset. This includes interest on loans used to acquire an investment property. In determining the deductibility of interest the courts and tribunals have looked at the use to which the borrowed moneys have been put. For example, interest on borrowed moneys may be deductible where the funds are used to acquire income producing assets. An outgoing of interest is incidental and relevant to the gaining of assessable income if the borrowed money is used for the purpose of gaining that income ( FC of T v. Munro (1926) 38 CLR 153 ( Munro’s Case )). A property settlement is not viewed as an isolated commercial transaction involving just tangible property, but is also associated with intangible personal entitlements and obligations of the parties stemming from the marriage. As part of the marriage settlement consent orders filed with the Relevant Law Court, you agreed to provide payment to your spouse which was expected to be sufficient to allow your spouse to: ● discharge the mortgages connected with dwelling M, and ● pay an amount to a third party. This would also allow your spouse to keep $B,000,000 as the sale price of dwelling M (or your spouse’s interest in it), but your spouse would be obligated to refund any excess to you. You have indicated that this later payment made by your spouse to you was $Z00,000 and covered your living expenses. It is considered that the monies that you have borrowed were not all used to acquire your spouse’s share of dwelling M. The monies were used in order for you to finance your overall obligations under the property settlement. The Relevant Court determined the net global value of the matrimonial asset pool totalled $P,000,000. The consent orders stipulated that the division of assets was to be split approximately 50/50 between you and your spouse. It is noted that one half of the matrimonial pool is $C,000,000. Therefore, it is reasonable to conclude that your spouse’s other net assets totalled about $D00,000 and the $B,000,000 payment aided in achieving a 50/50 split of the matrimonial assets. The size of the payment to your spouse reflects the existence of the other potential impediments to the transfer of dwelling M. It is very unlikely that the mortgage holder would have allowed the transfer without the mortgages being discharged. These were loans in your name for purposes that have not been completely disclosed. Payment of these outstanding amounts is not considered to be an element of the purchase of the dwelling M from your spouse. Therefore, the interest to the extent it relates to this matter will not be deductible against the rental income earned from dwelling M.