Private ruling: Interest expenses
Date of advice: 27 April 2016
Published: June 2016
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are you entitled to a deduction in the 2014-15 income year, for interest expenses that were not deducted from your account until the following financial year? | A1: Yes.

Relevant facts and circumstances: You own an investment property. You are not carrying on a business. In the relevant year you requested that your bank prepay the annual interest on the property, with the instruction that it was to be prepaid in the relevant financial year. The bank inadvertently missed deducting the amount before 30 June 20XX and was not deducted until the following financial year. You have provided a letter from your bank which confirms this.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1936 Section 82KZM | Income Tax Assessment Act 1936 Section 82KZL

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. 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. Where a borrowing is used to acquire an income producing asset, the interest on this borrowing is considered to be incurred in the course of producing assessable income. In your case, you utilised the loan funds to purchase an investment property. Therefore the loan interest is an allowable deduction. However as you are also prepaying the interest expense the application of section 82KZM of the Income Tax Assessment Act 1936 (ITAA 1936) must be considered. The effect of section 82KZM of the ITAA 1936 is to evenly spread the deduction for prepaid interest over the years comprising an 'eligible service period'. The 'eligible service period' is the period to which the interest relates, not the term of the loan, being a period not exceeding 10 years (subsection 82KZL(1) of the ITAA 1936). A prepaid expense will not be subject to these timing rules where the following factors exist: • the interest is otherwise deductible under section 8-1 of the ITAA 1997; • the taxpayer is an individual; • the expenditure was not incurred in carrying on a business; and • the eligible service period is 12 months or less. You are an individual who is not carrying on a business. The interest expense would be deductible under section 8-1 of the ITAA 1997 and the 'eligible service period' is 12 months. Accordingly, the interest is not subject to the timing rules in section 82KZM of the ITAA 1936 and is deductible in the year in which it is incurred. | Detailed Reasoning - When was the expense incurred?: Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions , provides guidance on when an expense is incurred. There is no statutory definition of the term 'incurred'; however, the ruling outlines general rules, settled by case law, which will assist in most cases in defining when an outgoing is incurred. Broadly, an expense is incurred at the time that a present money debt is owed and cannot be escaped. Importantly, a taxpayer need not have actually paid any money to have incurred such an outgoing, providing they are definitively committed to it in the year of income. That is, an expense may be incurred where there is a presently existing liability to pay a pecuniary sum. In your case, you had a presently existing liability when you authorised your bank to prepay the interest on or before 30 June 20XX. You were definitely committed to the outgoing in the relevant financial year and it was only due to an error on the banks part that the relevant entries were not made until the subsequent financial year. Therefore, the interest expense was incurred in the relevant financial year. As such you are entitled to claim a deduction for the prepaid interest in the relevant financial year.