Private ruling: Interest deduction
Published: October 2011
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you entitled to claim a deduction of the interest charged on your loans? | A1: No.

Relevant facts and circumstances: You had an investment loan with a balance on your rental investment property. You decided to move into your investment property and make it your principal place of residence. You intended to pay out this loan by taking out a new loan and adding cash from your share trading account. At the same time you took out a new investment loan. These transactions would have allowed you a loan on your principal place of residence and an investment loan. For taxation purposes you would have retained the interest deductibility on your investment loan. You were advised by your bank by letter that two new investment loans had been created and used to pay out your original investment 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 (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 moneys is considered to be incurred in gaining or producing assessable income. In your situation, the 'new borrowings' were used to repay a private debt and not for an income producing purpose. It is acknowledged that you intended that part of the new borrowings would be used for investment purposes. However, the Commissioner does not have any discretion to allow you a deduction for the interest incurred on the amount that was directed to a private purpose. As the loan amount was used for a non-income producing purpose, a deduction for the interest incurred is not an allowable deduction under section 8-1 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. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.