Private ruling: Interest deductions
Date of advice: 6 December 2023
Published: 22 January 2024
Ruling period: Year ended 30 June 2022 | Year ended 30 June 2023
Date scheme commenced: 1 July 2021

Ruling: Q1: Is interest on a property loan originally held for Property A fully deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), following the purchase of Property B? | A1: No. | Q2: Is interest on a property loan originally held for Property A deductible under section 8-1 of the ITAA 1997 as a proportion of funds held in your savings account equivalent to the loan amount owing at the time of purchase of Property B against the total account balance? | A2: No.

Relevant facts and circumstances: Person A and Person B jointly owned a property (Property A). Property A was refinanced with a bank loan with a (the loan). Property A was never used to earn assessable income. Property A was sold in 20XX with settlement occurring several months later. Following the sale of Property A, the loan was secured against the property where you currently reside. Proceeds from the sale of Property A were transferred to a savings account (the savings account). The loan was not paid down and remained open. Other loans held for Property A were closed at settlement. You paid a deposit following signing of the contract for purchase of Property B. Over a period of several months, several payments were made from the savings account jointly held by you to facilitate the purchase of Property B. You purchased Property B. As the total amount you paid for Property B was more than the purchase price, you received a refund of an overpayment amount on settlement. Property B was available for rent from the date of purchase and continued to be rented for the remainder of the income year.

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

Reasons for decision: Summary: You are not entitled to a deduction under section 8-1 of the ITAA 1997 on all of the interest incurred on the loan originally held for Property A following the purchase of Property B. | 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. The exception to this is where the outgoings are of a capital, private or domestic nature. Taxation Ruling TR 95/25 Income tax: deductions for interest under subsection 51(1) of the Income Tax Assessment Act 1936 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, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put. The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 (Munro's case) is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. The use is not altered in the case of a refinance. Paragraph 42 of TR 95/25 addresses borrowings used to repay an existing loan. The paragraph states "interest on a new loan will be deductible if the new loan is used to repay an existing loan, which, at the time of the second borrowing, was being used in an assessable income producing activity or used in a business activity which is defined to the production of assessable income ( Roberts and Smith ATC at 4388; ATR at 504). | Detailed Reasoning - Application to your circumstances: When you sold Property A, you did not pay down the loan associated with the property. Instead, you transferred the proceeds from the sale of the property into a savings account you hold with the bank and kept the loan on foot. You then purchased Property B, using funds from your savings account. The consequence of this is that Property B was not purchased with the borrowed funds. By transferring the proceeds from the sale into a savings account, rather than repaying the loan and reborrowing funds, you have severed the link between the borrowed funds and the acquisition of Property B. Therefore, as none of the borrowed funds were used to purchase Property B, you cannot deduct all of the interest incurred under section 8-1 of the ITAA 1997. | Summary: You are not entitled to a deduction under section 8-1 of the ITAA 1997 on any portion of the interest incurred on your loan following the purchase of Property B. | Detailed Reasoning - Detailed reasoning: As outlined in Question 1, where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities. The ruling establishes drawing any excess or available funds from a loan account is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put. This is independent of the purpose of the original borrowing. If this is for a non-income producing purpose, then the interest on the redraw amount is not deductible. The redraw facilities referred to in Taxation Ruling TR 2000/2 is where a borrower redraws previous repayments of the loan principal in a loan account. | Detailed Reasoning - Application to your circumstances: Upon the sale of Property A, the proceeds were deposited into a savings account held in your names. You have requested that deductions be allowed in proportion to an amount equivalent to the loan balance as against the total balance of your savings account. The amount is equivalent to the loan balance owing at the time of purchase of Property B. However, the funds used to purchase Property B were paid from the proceeds deposited into a savings account and not using the borrowed funds. There is no connection between the borrowed funds and the purchase of Property B. As none of the borrowed funds were used to purchase Property B, you cannot deduct any portion of the interest incurred under section 8-1 of the ITAA 1997.