Private ruling: Interest deduction
Date of advice: 14 April 2016
Published: June 2016
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Can you claim interest deduction for the period of term deposit? | A1: Yes

Relevant facts and circumstances: You purchased a house and land package (Property A). Property A was financed by the bank. You used Property A as your main residence until its sale. You had made plans to live in a second property (Property B). You found a block of land when you were in the process of selling Property A; you put an offer on the block of land. You intended to build a house on the block of land and use it as your main residence. Due to your personal circumstances changed, you kept the first loan open through a Flawed Asset Arrangement with the bank by putting the proceeds of Property A into a term deposit. Paragraph 3 of the Flawed Asset Arrangement - Deposit Letter states that you were not allowed to withdraw any funds from the term deposit until the bank had received all amounts owing. All interest earned from the term deposit was treated as assessable income. The bank refused to advance you further money for building on the block of land; therefore, you sold the land and triggered a capital gain event.

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 (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, or relate to the earning of exempt income. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith looks at the deductibility of interest. It states that the deductibility of interest depends upon satisfying, or being able to show, that the expense has sufficient connection with the operations or activities which directly gain or produce a taxpayers assessable income. In other words, the interest must be incurred in relation to a property or shares which are held for income producing purposes. It is also important to note the link is to the use of the funds not to that asset is used as security. TR 95/25 provides that the deductibility of interest is determined by the use for which the borrowed money is put. The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153 (Munro's Case), is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities provides the ATO view on the deductibility of interest on money drawn down on a loan with redraw facilities. In this ruling the Commissioner considers a redraw from a loan account, is a separate borrowing. Therefore, the deductibility of the interest on that separate borrowing depends on whether the interest is incurred in gaining or producing assessable income. To the extent borrowings are used for income producing purposes, that part of the accrued interest attributable to those borrowings is deductible. In your case, you took out a loan from the bank to purchase Property A. You used Property A as your main residence until its sale. You found a block of land when you were in the process of selling Property A; you put an offer on the block of land. You intended to build a house on the block of land and use it as your main residence. Due to your personal circumstances changed, you kept the first loan open through a Flawed Asset Arrangement with the bank by putting the proceeds of Property A into a term deposit and all interest earned from the term deposit was treated as your assessable income. It is considered that the proceeds of Property A which you put into term deposit was your separate borrowing and it was used to produce your assessable income; therefore, you are entitled to a deduction for the interest in relation to the term deposit under section 8-1 of the ITAA 1997. However, you can only claim interest deduction up to the amount of the assessable interest on the term deposit.