Private ruling: Rental property deductions
Date of advice: 12 August 2016
Published: September 2016
Ruling period: Year ended 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021
Date scheme commenced: 1 July 2016

Ruling: Question and answer | Are you entitled to a deduction for the interest incurred on a line of credit facility used to make interest only repayments on your investment property? | Yes.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. You own an income producing residential investment property. You currently have the following facilities (not linked) with your bank: Facility No. 1 - Investment property loan (interest only - 100% investment related) Facility No. 2 - Line of credit/overdraft Facility No. 3 - cheque account Facility no. 4 - home loan (100% private) Your objective is to accelerate the repayment of your personal home loan. The line of credit facility is used solely to make interest-only repayments in respect of your investment property loan. The use of the line of credit will result in you having more funds available in your personal cheque account to make repayments on your personal home loan. The available funds of the line of credit are used solely to make the interest only repayments of the investment property loan. The line of credit will continue to accrue interest charges in respect of the investment property loan repayments made. Repayment of the line of credit will not be required by the financier until the credit limit is reached.

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

Reasons for decision: Detailed Reasoning - Interest deduction: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for any loss or outgoing that is incurred in gaining or producing assessable income to the extent that it is not of a private, capital or domestic nature. The deductibility of an outgoing is determined by its essential character: Lunney v. Federal Commissioner of Taxation (1958) 100 CLR 478; 11 ATD 404; 7 AITR 166. The character of interest is determined by the purpose of the borrowing for which the interest is incurred. Generally, the purpose of a borrowing can be determined from the use of the borrowed funds and outgoings of interest for the borrowing ordinarily draw their character from that use ( Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 ( Fletcher ), Kidston Goldmines Limited v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168). It is, therefore, generally accepted that ordinary interest incurred on funds borrowed to acquire an income producing asset is an allowable deduction. Further, interest on a new loan will generally be deductible if the new loan is used to repay an existing loan. The refinancing you have undertaken will be used only for the purposes repaying an existing loan which is income producing and interest incurred is deductible. | Detailed Reasoning - Deductibility of Compound Interest: In the ensuing analysis, a distinction is made between 'additional interest' and 'further interest amount'. Additional interest is identified as the difference between the interest incurred on the Investment Line of Credit (LOC) and the interest that would be incurred on that account if you made interest and principal periodic payments to that account so as to repay all borrowings over the term of the LOC facility. The interest that accrues on the unpaid interest incurred on the Investment LOC is referred to as the 'further interest amount' or the 'compound interest amount'. It is important to note that the additional interest in this instance includes interest on interest, the compound interest amount. Generally, the further interest amount is incurred for the same purpose as the simple interest unpaid and for which it is incurred, and then it follows that it should be deductible, as the simple interest incurred on the Investment LOC is incurred for the purposes for which the borrowings under the Investment LOC were made and is deductible: Hart v. Federal Commissioner of Taxation (2002) 121 FCR 206; 2002 ATC 4608; (2002) 50 ATR 369 ( Hart ), Federal Court of Australia Full Court. However, Gyles J stated in the Federal Court of Australia decision at first instance Hart , that: It is not self-evident that this must always be so. There is ordinarily a choice as to whether to pay simple interest as it falls due. Put another way, the incurring of compound interest depends upon a decision not to pay simple interest as it falls due. Sometimes such a decision will be compelled by impecuniosity. That case can be left aside. Take a case where a private individual has the means to pay simple interest as it falls due on an investment loan, but chooses to purchase an object of art instead. It is not clear beyond argument that interest upon interest would be deductible as being incurred for the purpose of gaining or producing assessable income in those circumstances (cf Steele at ATC 4248-4249; CLR 470-471). In the present circumstances, the compound interest does bear the same character for taxation purposes as the interest which is capitalised and for which the compound interest is incurred. The payment of interest secures the use of the outstanding borrowed money during the term of the Investment LOC for the purposes for which that money was borrowed. To the extent that the outgoings of interest incurred can be properly characterised as of a kind referred to in the first limb of subsection 51(1) of the ITAA 1936, they must ordinarily draw their character from the use of the outstanding funds; see Fletcher . In this context, the funds used to acquire an income earning asset. Further, the capitalisation of interest is a feature of the contractual arrangement which cannot be severed and the interest on unpaid interest arises for the same purposes as the unpaid interest for which it is incurred. Under the LOC facility contract you are legally obliged to incur the further interest amount if you choose to capitalise the interest incurred on the Investment LOC. As such, the compound interest incurred on the Investment LOC will be incurred in earning assessable income and will be an allowable deduction. Consequently, the simple interest and compound interest incurred on the Investment LOC are allowable deductions under section 8-1 of the ITAA 1997 the funds have been used for income producing purposes.