Private ruling: Interest expenses
Date of advice: 19 October 2016
Published: January 2017
Ruling period: Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are you entitled to a deduction for the portion of interest expenses incurred on funds borrowed to purchase your family member's interest in the investment property where the property has been valued by a qualified valuer? | A1: Yes. | Q2: Are you entitled to a deduction for the portion of interest expenses incurred on funds borrowed to payout your portion of the outstanding joint loan for the investment property? | A2: Yes. | Q3: Are you entitled to a deduction for the portion of interest expenses incurred on funds borrowed to payout your family member's portion of the outstanding joint loan for the investment property? | A3: No. | Q4: Are you entitled to a deduction for the portion of interest expenses incurred on funds used to pay the associated transfer costs incurred in relation to the investment property? | A4: Yes.


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 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put. The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Accordingly, it follows that if a loan is used for investment purposes from which assessable income is to be derived, the interest incurred on the loan will generally be deductible. Alternatively, where borrowed funds are used for a private or domestic purpose, the interest on the borrowed funds will not be an allowable deduction. Further, interest on a new loan used to repay your portion of 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. Taxation Ruling IT 2167 Income Tax: rental properties - non-economic rental, holiday home, share of residence, etc. cases, family trust cases examines the situation where a property is let to relatives and non arms length transactions. Although you are not letting to relatives, you are dealing with a related party when purchasing the portion of the property, and therefore the principles outlined in this ruling are relevant. Where a person is dealing with relatives, the essential question is whether the arrangements are consistent with normal commercial practices. Where the arrangement is not at arm's length, an apportionment of losses and outgoings incurred is generally required. The test that should be considered to show whether the arrangement is at arm's length, is whether a reasonable person with no relationship to either party would enter into this arrangement using exactly the same terms and conditions. If the answer is yes, then it would be an arm's length arrangement. Whether parties are at arm's length is a question of fact. In your case you are purchasing a share in a rental property from your family member. If you are paying market value for the property and the title deed will be changed to reflect your full ownership interest, it is considered that you are dealing at arm's length and the arrangement is commercially realistic. Market value You have advised that you obtained a valuation from the real estate agent. For tax purposes a market valuation requires a valuation process carried out by a suitably qualified person. A market valuation may be undertaken by a registered valuer or a member of a recognised professional valuation body. People who assess market value should have specific knowledge, experience and judgment in that particular field. The valuation process should be adequately documented and kept with your tax records. To ensure the objectivity of the report, the valuer should be independent of the interest of the relevant party commissioning the report. In your case your real estate agent is not generally regarded as a suitably qualified valuer. You advised that your property was valued at $xxx. However a website shows your property value as being $xxx. Therefore it is questionable whether interest on borrowed funds would be fully deductible unless you have the relevant documentation from a suitably qualified person to show the true market value of your property. For further information please refer to Market valuation for tax purposes on the Australian Taxation Office website www.ato.gov.au Where an appropriate valuation has been obtained and your borrowed funds are used to acquire the relevant share of the income producing investment property, the associated interest expenses are an allowable deduction. Similarly, where the borrowed funds are used to pay your portion of the transfer fees, this portion of the interest expense is also an allowable deduction under section 8-1 of the ITAA 1997. You would also be entitled to a deduction for the portion of interest expenses incurred on funds refinanced and borrowed to payout your portion of the outstanding amount on the original loan. However, as the previous loan was in joint names, the refinanced portion of your family member's share of the loan is not an allowable deduction for you. That is you are not entitled to a deduction for the portion of interest expenses incurred on funds borrowed and used to pay the remaining portion of the loan belonging to your family member as this does not relate to your assessable income and is also of a private or domestic nature.

Relevant facts: You and your family member purchased a residential property. | You financed this purchase with a joint loan. The loan was used solely for the purchase of the residential property. This loan has a current outstanding balance. | You and your family member have now purchased a new residential property as joint tenants. This property will be your main residence. This purchase was financed via a joint loan. | The previous residential property has become an investment property. The property is rented and managed by a real estate agent. The property is rented at the market rate. | You wish to purchase your family members interest in the investment property. | The purchase of the portion of the investment property will be funded from a new loan solely in your name. | The funds from the new loan will be used to pay out the existing joint loan. The new loan will also be used to pay any associated transfer costs and the balance will be paid to your family member.