Private ruling: Deductibility of interest
Published: April 2015
Ruling period: Year ended 30 June 2014 to Year ended 30 June 2018
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is interest incurred on a line of credit deductible after the investment property is sold? | A1: Yes. | Q2: If you refinance the line of credit will the interest be deductible? | A2: Yes.

Relevant facts and circumstances: You acquired a rental property. You obtained a bank loan to fund the acquisition of the property. You set up a line of credit where all the rental income was deposited and all rental expenses, including interest, were paid from. The line of credit was never used for outgoings of a private or domestic nature. The rental property was negatively geared. At all times the property was available for rent and was rented. The property sold. The sale proceeds were sufficient to repay the bank loan in full. The remaining balance of the sale proceeds was applied against the line of credit but it was not sufficient to pay down the line of credit in full. You did not have any surplus cash available to repay the line of credit in full. No funds from the sale of the property were used to reduce your personal home loan. As surplus cash becomes available, it will be applied to reduce the line of credit.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 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. Interest on a new loan used to repay an existing loan that is used for income producing purposes will generally also be deductible as the character of the new loan is derived from the original borrowing (Taxation Ruling TR 95/25). Taxation Ruling TR 2004/4 provides the Commissioner's view on the deductibility of interest where the income-producing asset has been disposed of and the taxpayer is still liable for the balance of the loan. In general, the interest expense will continue to be deductible where: • the taxpayer borrowed money to acquire an income-producing asset • the income-producing asset has been disposed of • the proceeds from the disposal have been applied against the loan and not used for personal or non-income producing purposes • the taxpayer does not have the legal power to repay the loan ( FC of T v. Brown 99 ATC 4600, (1999) 43 ATR 1) or does not have the financial resources to repay the loan fully ( FC of T v. Jones 2002 ATC 4135, (2002) 49 ATR 188), and • is unable to avoid incurring ongoing interest liabilities. In this situation, a nexus will continue to exist between the interest outgoings and the relevant income earning activities at least until the end of the period during which the interest cannot be avoided. However, where it can be inferred that a taxpayer has: • kept the loan on foot for reasons unassociated with the former income earning activities, or • made a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred the nexus between the outgoings and relevant income-earning activities will be broken. In this case, you have disposed of your rental property. The sale proceeds were first applied to the bank loan and the remainder to the line of credit. We accept that a nexus continues to exist between the interest outgoings and the relevant income earning activities. Therefore, you are entitled to a deduction for interest incurred on the line of credit. As discussed in TR 2004/4, interest on a new loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing. That is, when a loan is refinanced, the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities. In this case you are considering refinancing the line of credit loan to obtain better terms. As per TR 2004/4, refinancing a loan does not itself break the nexus between the interest and income earning activities. Therefore, if you refinance the loan you will still be entitled to a deduction for the interest.