Private ruling: Interest and holding costs
Date of advice: 2 December 2016
Published: May 2017
Ruling period: Year ended 30 June 20YY | Year ended 30 June 20ZZ
Date scheme commenced: 20XX

Ruling: Q1: Are you entitled to a deduction for your interest expenses, rates and taxes incurred during the construction of your rental property? | A1: Yes.


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 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. Generally, interest expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances. 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 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, regard must be given to all the circumstances including the purpose of the borrowing and the use to which the borrowed funds are put. The interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income. The Commissioner's view on whether interest deductions are allowable prior to the commencement of income earning activities and the implications of the decision of the High Court in Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 ( Steele's case ) are outlined in Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities. In Steeles case, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. TR 2004/4 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 in the following circumstances: ● 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. While Steele's case deals with the issue of interest, the principles can be applied to other types of holding expenditure such as rates and land taxes. In your case you have purchased property and have agreed to the immediate construction. The construction will be completed after 200 days and then the property will be rented. Although rental income from the property may not be derived until the 20YY-ZZ financial year, it is considered that there is sufficient connection between your interest and holding expenses to the earning of your assessable income. It is considered that the requirements as outlined above are met. Consequently a deduction is allowable for the interest expense incurred on your investment loan under section 8-1 of the ITAA 1997. Similarly the costs for rates and land taxes incurred while the property is being constructed are sufficiently connected to the earning of your assessable income and are allowable deductions.

Relevant facts: You purchased a house and land package. | The property is to be solely used as a rental property. | The settlement for the land occurred first and then the property is to be constructed starting from settlement and lasting a period of approximately 200 days with progress payments to be made at various stages. | Interest expenses as well as rates and land taxes will be incurred before the property construction is finished and before the property will be available for rent.