Private ruling: Interest deduction and capital gains tax issues
Ruling period: Year ending 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Questions and answers: | Can you claim a deduction for interest incurred on the portion of a loan taken out to comply with a court order? | No. | Does the payment made to your former spouse under a court order, relating to the marital home, form part of the cost base or reduced cost base of the asset under Division 110 of the Income Tax Assessment Act 1997 (ITAA 1997)? | No.


Relevant legislative provisions: Income Tax Assessment Act 1997 - Section 8-1 | Income Tax Assessment Act 1997 - Division 110 | Income Tax Assessment Act 1997 - Section 110-25 | Income Tax Assessment Act 1997 - Section 110-55

Reasons for decision: Detailed Reasoning - Interest deduction: Section 8-1 of the 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. Taxation Ruling TR 95/25 considers the deductibility of interest. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed funds is considered to be incurred in gaining or producing assessable income and will be an allowable deduction. Alternatively, where borrowed funds are used for a private or domestic purpose, the interest on the borrowed funds will not be an allowable deduction. In your case, a portion of the funds you borrowed were used to comply with a court order to pay your former spouse a sum of money for their interest in the marital home, although you held sole legal title to the property. A taxpayer's marital arrangements are normally regarded as being private in nature. The interest you incur on this portion of the loan is not an expense incurred in gaining or producing your assessable income from the rental property as it is considered an expense relating to your marriage settlement. Accordingly the interest expense is regarded as being of a private or domestic nature and you are not entitled to a deduction for this expense. | Detailed Reasoning - Capital Gains Tax (CGT) - Cost base: Under Division 110 of the ITAA 1997, there are five elements which may be included in the cost base and reduced cost base of a CGT asset. These elements are the same for cost base and reduced cost based, except in relation to the third element. The five elements are: · First element - money paid or required to be paid and the market value of any other property given or required to be given in respect of acquiring a CGT asset (subsection 110-25(2) of the ITAA 1997). · Second element - incidental costs of acquiring a CGT asset; or that relate to a CGT event that happens in relation to the asset (subsection 110-25(3) of the ITAA 1997). · Third element - in respect of the cost base - non-capital costs of ownership of a CGT asset acquired after 20 August 1991 (subsection 110-25(4) of the ITAA 1997) or - in respect of the reduced cost base - various balancing adjustment amounts as set out in subsection 110-55(3) of the ITAA 1997. · Fourth element - expenditure incurred to increase the value of a CGT asset (subsection 110-25(5) of the ITAA 1997). · Fifth element - expenditure incurred to establish, preserve or defend your title or right over a CGT asset (subsection 110-25(6) of the ITAA 1997). In your case, the payment made to your former spouse was not paid to acquire a CGT asset as you have always been the legal owner of the property nor is it an 'incidental cost' as that term is defined in section 110-35 of the ITAA 1997. It does not constitute a non-capital cost and is not a balancing adjustment amount. The payment was not made to increase the asset's value nor was it incurred in respect of your title or right over the asset. Accordingly, the payment you made to your former spouse under a court order does not form part of the cost base or reduced cost base of the asset under Division 110 of the ITAA 1997.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns. | Relevant facts: You and your former spouse purchased a property after 20 September 1985. | The mortgage for the property was in both your names, but the legal title for the property remained in your name only. | You both contributed to the mortgage repayments. | In the 2010/11 income year a court ordered you to pay your now former spouse a sum of money for their interest in the property. | You refinanced your existing mortgage for the property to a loan in your name only, which included an amount paid to satisfy the court order. | The former marital home is now being used as a rental property.