Private ruling: Loan interest deduction
Date of advice: 2 November 2016
Published: February 2017
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Can you claim all the interest on a loan against your former primary place of residence as an investment expense when you will be using the loan to purchase a new primary residence? | A1: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 Reason for decision | Section 8-1 of the Income Tax Assessment Act 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 provides that the deductibility of interest is determined by the use for which the borrowed money is intended. 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 for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income. Paragraph 29 of TR 95/25 states: | In FC of T v. Munro (1926) 38 CLR 153 ( Munro ) the High Court considered whether interest incurred on a borrowing which was not used to produce assessable income, but was secured by an income producing asset, was deductible. The taxpayer argued that if the interest obligations were not discharged, the income producing asset that secured the borrowing would be in jeopardy. Thus, the discharge of the obligation to pay interest was incurred in producing assessable income. The High Court rejected this proposition. | Taxation Determination TD 93/13 also considers the relevance of security provided for a loan and establishes the principle that deductibility is determined by the use of the borrowed money and the choice of assets used as security for a loan is irrelevant. TD 93/13 examines the situation where a non-income producing asset is used as security for a loan to purchase an income producing asset. The interest is deductible because of the use to which the borrowed money is applied. Equally, where an income producing asset is used as security for a loan to purchase a non-income producing asset the interest will not be deductible. | The application of the above to the question you pose is available in the Australian Taxation Office publication Rental Properties 2016 . It states on page 13: | Some rental property owners borrow money to buy a new home and then rent out their previous home. If there is an outstanding loan on the old home and the property is used to produce income, the interest outstanding on the loan, or part of the interest, will be deductible. However, an interest deduction cannot be claimed on the loan used to buy the new home because it is not used to produce income. This is the case whether or not the loan for the new home is secured against the former home. | Application to your circumstances | In your case, the purpose of the loan will be to make funds available to purchase a home which you will live in. The loan will not be for the purchase of an income producing asset. | In applying the use test, the character of the interest on the money borrowed under this loan will not have sufficient connection with the operations or activities involved in gaining your assessable income as it will not be used to acquire an income producing asset. The money borrowed will be used for a private purpose. | Accordingly you are not entitled to a deduction under section 8-1 of the ITAA 1997 for any of the interest incurred on the portion of the loan used to purchase a new primary residence.

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 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 provides that the deductibility of interest is determined by the use for which the borrowed money is intended. 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 for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income. Paragraph 29 of TR 95/25 states: In FC of T v. Munro (1926) 38 CLR 153 ( Munro ) the High Court considered whether interest incurred on a borrowing which was not used to produce assessable income, but was secured by an income producing asset, was deductible. The taxpayer argued that if the interest obligations were not discharged, the income producing asset that secured the borrowing would be in jeopardy. Thus, the discharge of the obligation to pay interest was incurred in producing assessable income. The High Court rejected this proposition. Taxation Determination TD 93/13 also considers the relevance of security provided for a loan and establishes the principle that deductibility is determined by the use of the borrowed money and the choice of assets used as security for a loan is irrelevant. TD 93/13 examines the situation where a non-income producing asset is used as security for a loan to purchase an income producing asset. The interest is deductible because of the use to which the borrowed money is applied. Equally, where an income producing asset is used as security for a loan to purchase a non-income producing asset the interest will not be deductible. The application of the above to the question you pose is available in the Australian Taxation Office publication Rental Properties 2016 . It states on page 13: Some rental property owners borrow money to buy a new home and then rent out their previous home. If there is an outstanding loan on the old home and the property is used to produce income, the interest outstanding on the loan, or part of the interest, will be deductible. However, an interest deduction cannot be claimed on the loan used to buy the new home because it is not used to produce income. This is the case whether or not the loan for the new home is secured against the former home. Application to your circumstances In your case, the purpose of the loan will be to make funds available to purchase a home which you will live in. The loan will not be for the purchase of an income producing asset. In applying the use test, the character of the interest on the money borrowed under this loan will not have sufficient connection with the operations or activities involved in gaining your assessable income as it will not be used to acquire an income producing asset. The money borrowed will be used for a private purpose. Accordingly you are not entitled to a deduction under section 8-1 of the ITAA 1997 for any of the interest incurred on the portion of the loan used to purchase a new primary residence.

Relevant facts: You have nearly paid off the loan on your place of residence. | You wish to purchase a new property to live in, and use the existing property as an investment property, to rent out. | You will arrange a mortgage against the existing property, and will use the funds to purchase your new primary place of residence.