Private ruling: deductibility of interest
Published: October 2013
Ruling period: § Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Are you entitled to a deduction for 100% of the interest incurred on an investment loan, where you have made additional loan repayments of private income, and withdraw those funds at a later date for private use? | A1: No. | Q2: Are you entitled to a deduction for a portion of the interest incurred on an investment loan, where you have made additional loan repayments of private income, and withdraw those funds at a later date to be used for private purposes? | A2: Yes. | Q3: Are you entitled to a deduction for 100% of the interest incurred on an investment loan, where you have deposited private income to an acceptable loan offset account and later withdraw the funds for private use? | A3: Yes.

Relevant facts and circumstances: You are looking to establish a loan with a financial institution for the purpose of purchasing an income producing investment property. The loan will operate in conjunction with an offset account. You are considering applying private funds to the investment loan, to later withdraw and use for private purposes. You are also considering applying private funds to the offset account, to later withdraw and use for private purposes. You spoke to a representative of the ATO who advised that the deductibility of interest depends on the purpose for which the funds are used. You state that the purpose of the use of the funds is clear, in that the funds are private in nature, they may be deposited to either the investment loan or offset account and would be later withdrawn to use for a private purpose. Therefore, you believe that if the transactions are documented, you should be able to withdraw the funds and there not be a negative consequence on the deductibility of interest on the investment loan. You are not entitled to receive interest on the amounts held in the offset account. However your lender will allow you to offset the balance of offset account against your loan borrowings, to reduce the amount of interest charged on the borrowings. The interest on the investment loan reduced up to the amount of interest which would have been charged on the loan amount, equal to the balance of the offset account.

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

Reasons for decision: Summary: Section 8-1 of the Income Taxation Assessment Act 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. Funds paid to investment loan In Taxation Ruling TR 2000/2 the Commissioner discusses the deductibility of interest expenses incurred on loan agreements entered into by taxpayers which allow previous repayments of the loan principal to be redrawn. While the focus of TR 2000/2 is on mixed purpose sub-accounts, the same principles apply to other loan facilities used for mixed purposes. Paragraphs 39 to 44 of TR 2000/2 discusses further borrowings of a loan facility after repayment of some of the principle has been made. It states that where payments to the loan facility are made to discharge part of the loan debt, the funds used to make extra repayments simply cease to exist as an asset of the borrower. Therefore, although a loan agreement may give the borrower the right to borrow a further amount up to the balance of the loan debt after repayment to the loan facility, we consider the further borrowing a separate borrowing to the original. As such, the deductibility of the interest on that separate borrowing depends on whether the interest is incurred in gaining or producing assessable income. In your case, if you were to make additional loan repayments of private income and then draw down on the loan facility for private purposes, the further borrowing is considered a separate borrowing and the additional interest charged on the new borrowing would not be deductible. Funds paid to investment loan offset account Taxation Ruling TR 93/6 outlines the Commissioner's view on interest offset arrangements which are used to reduce the interest payable on a taxpayer's loan account. TR 93/6 provides that an acceptable loan account offset arrangement with dual accounts operates as follows: § there are two accounts - a loan account and a deposit account (offset account). It is accepted that where the offset account is a sub-account, it will be treated as a separate account § no interest is received on the offset account, and § the interest on the loan can only be reduced to the extent of the amount of interest which would have been charged on the loan amount, equal to the balance of the offset account. A taxpayer with an acceptable loan account offset arrangement is entitled to claim a deduction for the full amount of interest incurred on the loan account, whilst the loan is used wholly for income producing purposes. This will remain the case even if funds are withdrawn from the offset account and used for non-income producing purposes. Depositing funds into the offset account will decrease the interest payable on the loan account, but will not decrease the balance of the loan account. Withdrawing funds from the offset account will increase the interest payable on the loan account, but will not increase the balance of the loan account. In your situation, the investment loan would be used to fund the purchase of an income producing property and it would operate in conjunction with an offset account. Any credit balance of the offset account will reduce the interest payable on your loan. The amount of interest reduction will be the amount which would have been charged on the loan amount equal to the deposit before taking into account the offset. Consequently the loan and offset account is considered to be an acceptable loan offset arrangement and you would be entitled to a deduction for the interest charged on the investment loan. This would remain the case where funds are withdrawn from the offset account and used for either income or non-income producing purposes.