Private ruling: Interest deductions
Published: September 2014
Ruling period: Income year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you entitled to a deduction for the reduced amount of interest incurred on your rental loan after setting up an offset account? | A1: Yes

Relevant facts and circumstances: You have an investment loan which you used to purchase a rental property. You claim the interest incurred on this loan as a deduction. You wish to set up an offset account linked to the rental loan so that you can reduce the total interest incurred on your rental loan. You will not be entitled to interest for amounts deposited in the offset account. The offset account will be from the same financial institution as the rental loan.

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

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. Taxation Ruling TR 95/25 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 Commissioner's view on whether the use of an offset account will affect the deductibility of an interest expense is contained in Taxation Ruling TR 93/6. Paragraph 7 to 9 provides what the Commissioner views as an acceptable loan account offset arrangement: 6. The customer operates two accounts - a loan account and a deposit account. To be acceptable, it is essential that there be no entitlement, either in law or in equity, to receive interest payments or payments in the nature of interest on the amounts credited to the deposit account. The only benefit arising in the deposit account should be the right of the customer to ensure that the interest payable on the loan account is reduced in the way described in paragraph 7. 7. The reduction in the loan account interest referred to in paragraph 6 should be achieved by offsetting the balances of the two accounts. That is, the interest payable on the loan account should be calculated by dividing the outstanding loan principal into two components. A reduced rate of interest (often the lending rate less the ordinary deposit account rate) is charged on an amount equal to the balance of the deposit account. The reduced interest rate can never be a negative, ie. the deposit rate used cannot exceed the loan rate used. In those cases where the deposit rate would exceed the loan rate the deposit rate actually used in the calculation must be limited to the loan rate (see Example 3, paragraphs 31 and 32). The usual lending rate of interest on loans of this type is charged on the remainder of the loan principal. 8. If an account is made up of a series of sub-accounts, some of which are used for deposits and some for loans, then the sub-accounts will be treated, for the purposes of this Ruling, as separate accounts. Consequently, a loan offset account arrangement involving such accounts will fall for consideration under the principles applying to dual accounts (paragraphs 6 and 7). | Detailed Reasoning - Further at paragraph 17:: 17. If the loan account offset arrangement links a savings account with a loan on which the interest is deductible, the deduction allowable to the customer for the interest cannot exceed the reduced amount of interest (i.e., the interest payable after the offset has been taken into account) actually incurred by the customer. It is considered that your proposed arrangement will be an acceptable loan account offset arrangement as specified in TR 93/6 consequently you will be entitled to a deduction for the reduced amount of interest paid after the offset is taken into account.