Private ruling: Interest expenses
Published: October 2013
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 2013

Ruling: Q1: Are you entitled to a deduction for interest expenses incurred on loan money used to purchase a block of land on which you will later construct an investment property? | A1: No.


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. Generally, interest expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances. The Commissioner's view on whether interest deductions are allowable prior to the commencement of income earning activities and the implications of the decision of the High Court in Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 ( Steele's case ) are outlined in Taxation Ruling TR 2004/4. In Steele's case, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. TR 2004/4 concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances: · the interest is not incurred too soon, is not preliminary to the income earning activities, and is not a prelude to those activities, · the interest is not private or domestic, · the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost, · the interest is incurred with one end in view, the gaining or producing of assessable income, and · continuing efforts are undertaken in pursuit of that end. While Steele's case deals with the issue of interest, the principles can be applied to other types of holding expenditure including local council rates. Similar issues were also discussed in Temelli v. FC of T 97 ATC 4716; (1997) 36 ATR 417 ( Temelli's case ). In this case it was found that there was not a sufficient connection between the interest paid and the prospective income producing activity for a deduction to be allowed. In Temelli's case the taxpayers purchased a block of land with the intention of building a house for rental purposes. Three years later, they had not proceeded beyond having drawings and cost estimates prepared. In distinguishing the matter from the earlier decision of the Full Federal Court in Steele v. FC of T 97 ATC 4239 (Steele), the Court noted at 4243 that Steele had demonstrated the required commitment to the redevelopment of grazing land into a motel and townhouse complex. After purchasing the land, Steele had in fact obtained Councils assent to a zoning change, employed architects and engineers, entered into a joint venture arrangement and pursued the project with some tenacity until litigation with her collaborator put a complete stop to it. She demonstrated her commitment from the beginning by putting $1 million into the venture plus the time, energy and considerable expense of the subsequent architectural and engineering work and negotiations with the local council, sewerage authority and prospective joint venturers and financiers. The level of commitment demonstrated by Steele to the project was not an issue in the appeal to the High Court. In Temelli's case the Court found that the taxpayers had not made a decision to proceed with the building of a house on the land for a number of years. Their lack of commitment to the project lead to the conclusion that the associated expenses were not an allowable deduction. In your case you are purchasing a vacant block of land for constructing an investment property. However until the sale of your other investment properties, you will not be having plans drawn up. Although your intention is to eventually gain assessable rental income from the investment, due to your financial position, continuing efforts to have the investment property constructed will not commence immediately. It is considered that your circumstances are more in line with those in Temelli's case rather than Steele's case . That is, the required commitment to the project does not exist, as established in Steele , and that the necessary connection between the outgoings and the assessable income is not present. Therefore, you are not entitled to claim a deduction for interest or rates relating to the land while waiting for your investment properties to sell and your financial position to improve. The expenses are incurred at a point too soon to be an allowable deduction under section 8-1 of the ITAA 1997.

Relevant facts: You are in the process of purchasing a block of vacant land on which you will construct an investment property. | In order to afford the construction and to free up cash flow you will be selling some existing investment properties. | You do not want to sell at a loss and in the current real estate climate, the sale of the properties may take time. | You expect your overall timeframe for selling the properties, having plans drawn, approvals issued and construction to be completed to take approximately two to three years. | This will allow you to gain some equity in the land to assist offsetting costs and to allow greater borrowing. | You will have the plans drawn up after the sale of your existing properties.