Private ruling: Related entity loan and interest deductions
Published: October 2012
Ruling period: Year ended 30 June 2013. | Year ended 30 June 2014.
Date scheme commenced: 1 July 2012.

Ruling: Question and answer: | Is the interest you incur on a loan with a related entity for a rental property deductible? | Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 26-35 | Income Tax Assessment Act 1997 section 995-1(1)

Reasons for decision: Detailed Reasoning - Interest deductibility: 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. It is also worth noting that, whether interest is allowable as a deduction depends upon the purpose for which the money was borrowed or applied, not the asset against which the borrowed money was secured. | Detailed Reasoning - Payments to related entities: Payments to related entities are deductible only to the extent to which, in the Commissioners opinion, they are reasonable in amount. Any amount in excess of a reasonable amount is not deductible (and is neither assessable income nor exempt income of the related entity as per section 26-35 of the ITAA 1997.) In determining what the Commissioner would consider is a "reasonable" payment or liability for the purposes of section 26-35 of the ITAA 1997, the Commissioner has had regard to commercial rates of pay for comparable services. ATO ID 2006/239 discusses that If the amount paid to the related entity is equivalent to an arm's length payment, the whole payment will be considered to be a reasonable amount. A relative is exhaustively defined in section 995-1(1) of the ITAA 1997, as a spouse or any of the following: a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the person or that person's spouse. In your case, you intend to gain assessable income from renting a property which will be funded by a related entity loan with a family member. The Commissioner would consider, an amount of interest incurred on a related entity loan, deductible so long as an arms length arrangement exists between you and the related entity; for example having regard to commercial and comparable: · loan conditions/terms at the time, · interest rates, and · use of the rental property. As you will be the sole titleholder of the property, any interest expense incurred by you, from the time the property is rented or becomes available for rental purposes is deductible.

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. | Relevant facts: You are seeking to purchase an investment property in Australia. | You intend to purchase a property by the start of future year. | The purchase will be entirely funded by interest only loan. | The loan will be between yourself and a family member. | The loan will be fully commercial arms-length terms and reflect the terms that would typically apply if the loan were taken out at a mainstream financial institution. | Specifically the terms will be: | · the loan will be for a term of X years; | · the loan will be unsecured; and | · the interest rate charged will be fixed and set at the commencement of the loan to equal the interest rate that would be charged for a fixed rate unsecured loan. | The loan will be fully and formally documented, including: | · a legally binding loan agreement; and | · an annual statement detailing the total interest incurred and paid during the financial year, the opening and closing balance of the loan and any draw downs during the financial year. | The loan will be in your name only. | You do not intend to have any refinancing on the loan. | The loan will be used entirely for the purchase of the rental property. | Interest payments will be paid from your wages, and rent received from the property.