Private ruling: Interest expense
Date of advice: 17 September 2015
Published: September 2015
Ruling period: Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you entitled to a deduction for 100% of the interest incurred on a loan taken out to purchase a rental property unit off the plan? | A1: Yes | Q2: Are you entitled to a deduction for interest incurred on a loan used to purchase your main residence as a result of monies withdrawn from a linked offset account where the amounts are used to purchase the rental property? | A2: No

Relevant facts and circumstances: You have purchased house and land package and you intend to use the property for income producing purposes once construction is completed. The total cost of the package is $X. You have taken out an interest only investment loan in the amount of $X to purchase the package, with the remaining amount coming from an existing home loan offset account that is connected to your main residence. The legal title of the property is in your name only and you are solely responsible for the loan repayments. You signed the purchase contract for the package, and paid a 10% deposit. The funds used to pay the deposit were drawn from your offset account. You also paid stamp duty on the purchase in 20XX and this amount was also withdrawn from the offset account. You have incurred additional interest expenses on your main residence as a result of these withdrawals. Settlement for the land purchase is expected to be in 20YY and construction is expected to be completed in 20YY. The balance of the purchase price will fall due on settlement.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 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. 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. In your case you purchased a house and land package, with the intention of using the property for income producing purposes once completed. As the interest expense already incurred was solely for income producing purposes, they are not considered to have been incurred at a point 'too soon' prior to the commencement of the income producing activity. In your situation, it is accepted that the interest incurred is referrable to the purchase of the rental property, and is therefore incurred in the production of your assessable income. Accordingly you are entitled to a deduction for all interest incurred on the loan, from the date the deposit was drawn down. Interest incurred on money borrowed to purchase income producing investments such as shares is an allowable deduction. However, interest incurred on money borrowed for a private purpose is not deductible. In your case, you have a home loan that has an offset account attached. You can deposit and withdraw money from the offset account for day to day transactions. The interest incurred on the home loan is reduced based on the balance of the offset account. Withdrawing money from the offset account increases the interest on the home loan, and does not change the character of that money from savings to borrowings. Section 995-1 of the ITAA 1997 defines the term borrowing; borrowing means any borrowing, whether secured or unsecured, and includes the raising of funds by the use of a bond, debenture, discounted security or other document evidencing indebtedness. The money withdrawn from the offset account is not in the form of borrowings and will not incur any interest. The amount withdrawn is reflected as a reduction in your savings. Consequently, any use to which these funds are put (including an income producing purpose) is funded by your savings and not new borrowings (indebtedness). All the interest payable on the home loan account will still relate to the private purpose of purchasing your home. Therefore, the increased interest on your home loan, as a result of withdrawing funds from the offset account and using those funds for investment purposes, is not an allowable deduction under section 8-1 of the ITAA 1997.

Issue: Deductibility of interest expense