Private ruling: interest expenses
Published: July 2012
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2002

Ruling: Q1: Is interest incurred on borrowings for the construction of rental units an allowable deduction after the intention to rent has been changed to an intention to sell? | A1: No

Relevant facts and circumstances: You acquired a residential property some years ago. The property was used as a rental property for several years. You signed a contract to demolish the original residence and build units. Your intention when signing the contract was to rent the units upon completion of the construction. You were subsequently advised by your local council that they would not allow the units to be occupied and operated as short stay accommodation. After receiving your local council's decision, your intention changed from renting the units to selling them upon completion of the construction.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 110-25

Reasons for decision: Summary: Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income. 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 criterion. The interest will be deductible to the extent that the property is used to produce assessable income. In your case, you initially intended to rent the units once construction was completed to gain assessable income from renting the units. Once your intention changed from renting the completed units to selling them, the use of the borrowed funds also changed to that of a capital nature. You are entitled to claim a deduction for the period up to the date that your intention changed from renting to selling the completed units. After your intention changed from renting to selling the completed units, you are not entitled to a deduction for the interest incurred.

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