Private ruling: Pre-paid interest expenses - timing of deduction
Published: May 2013
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Are you entitled to a deduction in the 2011-12 income year for interest expenses that were not deducted from your account until the 2012-13 income year? | A1: Yes

Relevant facts and circumstances: You own an investment property that has been rented for the past 12 months and is expected to be rented for the next 12 months. You had arranged with your financial institution to make interest in advance payments on the loan relating to your rental property for the period 1 July 2012 to 30 June 2013. The interest amount was due to be deducted from your bank account prior to 30 June 2012. However, due to a processing error by your financial institution, the amount was not deducted until after 30 June 2012. You have provided a copy of your loan statement that shows a debit to the account for the interest amount prior to 30 June 2012, however the credit for the payment is dated after this date.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1936 section 82KZM | Income Tax Assessment Act 1936 section 82KZL

Reasons for decision: Summary: The interest expense was incurred in the 2011-12 income year as you had a presently existing liability to pay the interest during that year. You are therefore entitled to a deduction for the interest in the 2011-12 income year. | Detailed Reasoning - Detailed reasoning: 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. In your case, the loan relates to an investment property. Rent received from an investment property is assessable income; therefore the loan interest is an allowable deduction. | Detailed Reasoning - When was the expense incurred?: There is no statutory definition of the term 'incurred'. However, Taxation Ruling TR 97/7 outlines general rules which will assist in most cases in defining when an outgoing is incurred. Broadly, an expense is incurred at the time that a present money debt is owed and cannot be escaped. Importantly, a taxpayer need not have actually paid any money to have incurred such an outgoing, providing they are definitively committed to it in the year of income. That is, an expense may be incurred where there is a presently existing liability to pay a pecuniary sum (paragraph 6(a) TR 97/7). In your case, you had a presently existing liability when your loan account was debited for the interest amount. You were definitely committed to the outgoing in the 2011-12 income year and it was only due to a bank error that the relevant transactions did not occur until the 2012-13 income year. Therefore, the interest expense was incurred in the 2011-12 income year. | Detailed Reasoning - Prepaid expenses: As you have prepaid the interest expense, the application of the prepayment rules contained in section 82KZM of the Income Tax Assessment Act 1936 (ITAA 1936) must be considered. The effect of section 82KZM of the ITAA 1936 is to evenly spread the deduction for prepaid interest over the years comprising an eligible service period. The eligible service period is the period to which the interest relates, not exceeding 10 years (subsection 82KZL(1) of the ITAA 1936). A prepaid expense will not be subject to these timing rules where the following factors exist: · the interest is otherwise deductible under section 8-1 of the ITAA 1997 · the taxpayer is an individual · the expenditure was not incurred in carrying on a business · the eligible service period is 12 months or less, and · the eligible service period ends in the expenditure year or the income year immediately following. In your case you are an individual and the interest expense is deductible under section 8-1 of the ITAA 1997. The eligible service period is 12 months, ending in the income year immediately following the year in which the expense was incurred. Accordingly, the interest is not subject to the prepayment rules in section 82KZM of the ITAA 1936 and is deductible in the year in which it is incurred. Accordingly, you are entitled to claim a deduction for the prepaid interest in the 2011-12 income year.