Private ruling: Loan interest
Published: February 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Can you claim a deduction for interest paid on a loan where the money is deposited into a mortgage offset account? | A1: No.

Relevant facts and circumstances: You own a rental property in Australia and have lived and worked overseas for several years. You borrowed from an Australian bank to finance the purchase of the property. You have since raised another loan with an overseas bank and wish to deposit the funds from this loan into the mortgage offset account in Australia which is associated with your rental property. The purpose of this is to reduce the interest you will pay on the property loan in Australia.

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

Reasons for decision: Detailed Reasoning - Interest deductions: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for losses or outgoings to the extent to which they are incurred in gaining or producing assessable income. However you cannot deduct a loss or outgoing to the extent that the losses or outgoings are of a capital, private or domestic nature or another provision of the Act prevents you from deducting it. Taxation Ruling TR 95/25 provides the Commissioners view regarding the deductibility of interest. An outgoing of interest is incidental and relevant to the gaining of assessable income if the funds were borrowed for the purpose of gaining that income ( FC of T v. Munro (1926) 38 CLR 153; (1926) 32 ALR 339). The use test is the basic test relied upon to establish the deductibility of interest and looks at the application of the borrowed funds as the main criterion. Accordingly, where a loan is used for an income-producing purpose the interest on the loan is generally deductible. | Detailed Reasoning - Funds deposited into offset account: Taxation Ruling TR 93/6 considers loan account offset arrangements which are used to reduce the interest payable on a customer's loan account. TR 93/6 provides that an acceptable loan account offset arrangement with dual accounts operates as follows: · There are two accounts; a loan account and a deposit account. · No interest is received on the deposit account · The interest on your loan can only be reduced to the extent of the amount of interest which would have been charged on the loan amount equal to the balance of your deposit account. For example, you have a loan of $250,000 and a credit balance in your deposit account of $50,000. You can only obtain a maximum reduction of interest as if the balance of your loan was $200,000 (reduced by the $50,000 balance of your deposit account). A taxpayer with an acceptable loan account offset arrangement with dual accounts is entitled to claim a deduction for the interest actually incurred on the loan account whilst the loan is used wholly for income producing purposes. This will remain the case even if funds are withdrawn from the deposit account and used for non-income producing purposes. This is because depositing funds into the deposit account will decrease the interest payable on the loan account but will not decrease the balance of the loan account and withdrawing funds from the deposit account will increase the interest payable on the loan account but will not increase the balance of the loan account. In your case, you have a loan account offset arrangement. The interest payable on your loan account would be reduced by the amount of interest that would have been charged on an amount equal to the balance of your deposit account. However, as the money in the offset account does not receive any interest any interest incurred on monies borrowed to place into the offset account would not be deductible as they are not being used to produce assessable income.