Private ruling: Interest expenses
Published: October 2014
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you entitled to a deduction for the interest incurred on the investment loan sub-account? | A1: Yes. | Q2: Are you entitled to a deduction for the interest incurred on the investment loan sub-account where it is paid for by drawing down on a margin loan secured by a managed investment? | A2: Yes. | Q3: Are you entitled to a deduction for the capitalised interest incurred on the margin loan facility? | A3: Yes.

Relevant facts and circumstances: You have a line of credit account with a commercial lender. The account has 2 sub-accounts - a private and an investment sub-account. The investment account was used for income producing purposes. Interest was not capitalised to the investment loan - it was swept over to the private loan. You now plan to use the equity in your home to draw down on the investment loan sub-account and make another income producing purpose investment. Interest will not be capitalised to the investment loan sub-account. You propose to use the income producing asset to secure a margin loan facility with a commercial lender and draw down on the margin loan to pay for the interest on the investment loan sub-account. The interest accruing on the margin loan facility will be capitalised to the margin loan facility.

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

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows you a deduction for any loss or outgoing that is incurred in gaining or producing your assessable income, to the extent that it is not of a private, capital or domestic nature. Whether interest has been incurred in the course of gaining or producing assessable income generally depends on the purpose of the borrowing and the use to which the borrowed funds are put. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith states that where a borrowing is used to acquire an assessable income producing asset, or relates to expenses of an assessable income producing activity, the interest on this borrowing is considered to be incurred in the course of gaining or producing assessable income. 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. Further, interest on a new loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing. Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities contains the Commissioner's view on the deductibility of interest with regards to line of credit and redraw facilities. We consider a draw-down from a line of credit account or sub account, or a redraw from a loan account, is a separate borrowing. To the extent borrowings are used for income producing purposes, that part of the accrued interest attributable to those borrowings is deductible. Conversely, that part of the accrued interest attributable to borrowings for non-income producing purposes is not deductible. Taxation Determination TD 2008/27 Income tax: is the deductibility of compound interest determined according to the same principles as the deductibility of other interest? states that compound (or capitalised) interest, as with ordinary interest, derives its character from the use of the original borrowings. In your case, it is accepted that the interest incurred on the investment loan sub-account, and the interest capitalised on the margin loan have been incurred in the course of earning assessable income. Additionally, where the interest is paid by drawing down on a margin loan secured by a managed investment it is still considered to be in respect of an income producing asset. Therefore, you are entitled to a deduction for the interest incurred under section 8-1 of the ITAA 1997.