Private ruling: Interest deduction
Date of advice: 7 July 2016
Published: August 2016
Ruling period: Year ended 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2015

Ruling: Q1: Are you entitled to a deduction for interest in relation to the proposed arrangement? | A1: No.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. You and your spouse have several residential rental properties with a mix of sole ownership and joint ownership. You have two rental properties solely in your name which you solely account for in your tax returns. Although the title to the properties are in your name only the bank has drawn up documents stating that you and your spouse are jointly responsible for the loans. Originally a number of loans were moved to a bank. The bank incorrectly listed your spouse because they wanted to 'spread their risk'. The loans on the separately owned properties were moved to be solely in your name as soon as you realised the implication of this bank error. Your spouse is selling a property which is held in their name as sole owner. As a result surplus funds of approximately $xxx,xxx will be available. You wish to borrow the surplus funds from your spouse and use the funds to reduce the loans on the two rental properties that are owned solely by you. You will have a written loan agreement between you and your spouse. You will make interest only payments to the loan each month. The loan will be unsecured, as the security is based on your relationship only. You currently pay X% interest to the bank. There are several possible rates interest rates that your spouse will charge you; they are the rate for 'trust loans' as approved by the ATO; the 'as charged' rate as per the present bank loan; the 'official cash rate' plus a margin. You stated that the arrangement will help you and your spouse as they will only receive X% interest if the surplus funds were deposited in a bank. Your spouse is not in the business of lending money.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision: Summary: It is not considered that the proposed borrowing from your spouse is on a commercial basis. Rather it is considered that the arrangement with your spouse is largely private in nature and therefore no deduction is allowable under section 8-1 of the Income Tax Assessment Act 1997 . | Detailed Reasoning - Detailed reasoning: 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. A number of significant court decisions have determined that for an expense to be an allowable deduction: • it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense ( Lunney v. FC of T ; (1958) 100 CLR 478, • there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL v. FC of T , (1949) 78 CLR 47, and • it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income ( Charles Moore Co (WA) Pty Ltd v. FC of T , (1956) 95 CLR 344; FC of T v. Hatchett , 71 ATC 4184). 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. 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, regard must be given to all the circumstances including the purpose of the borrowing and the use to which the borrowed funds are put. Where a person borrows money from a related entity, the deductibility of interest will be dependent on whether the money is borrowed on a commercial basis. 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 and commercial arrangement. In your case you will borrow approximately $xxx,xxx from your spouse and repay part of the loans on two properties solely owned by you. While it is acknowledged that they are income producing properties, consideration must be given to the commerciality of the arrangement between you and your spouse. Factors which point towards the arrangement being uncommercial in character include: • The loan is unsecured. • The security is based on your relationship only. • The payments made to your spouse can be used for household expenses which can also benefit you. • A genuine liability paid to a third party does not generally generate a benefit to you. • You and your spouse haven't decided on the interest rate that will be charged for the loan. There are several possible rates that you may use. The fact that there is no definite interest rate yet indicates that this is not a commercial loan. Although you will have a written agreement with your spouse, this does not convert the arrangement into a commercial loan. It is not considered that you would be able to enter such an arrangement with an unrelated party. Having regard to all your circumstances, it is not considered that the proposed borrowing from your spouse is on a commercial basis. Rather it is considered that the arrangement with your spouse is largely private in nature and therefore no deduction is allowable under section 8-1 of the ITAA 1997.