Private ruling: Interest deductions and Part IVA
Published: March 2013
Ruling period: Year ending 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: 1. Are you entitled to a deduction for the portion of interest expenses incurred on funds borrowed to purchase 50% of your spouse's interest in the investment property? | A3: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 - Section 8-1 | Income Tax Assessment Act 1936 - Part IVA | Income Tax Assessment Act 1936 - Section 177A | Income Tax Assessment Act 1936 - Section 177C | Income Tax Assessment Act 1936 - Section 177D | Income Tax Assessment Act 1936 - Section 177F

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 considers the deductibility of interest. 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 criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed funds is considered to be incurred in gaining or producing assessable income and will be an allowable deduction. Alternatively, where borrowed funds are used for a private or domestic purpose, the interest on the borrowed funds will not be an allowable deduction. In your case, you intend to borrow money to purchase a 50% share of property A, current owned solely by your spouse. The 50% share of property A will be purchased at market value. You intend to re-build an investment property on property A, and may borrow additional funds to do this. As the borrowed funds will be used to acquire an income producing asset, you would be entitled to a deduction for the portion of interest expenses incurred on funds borrowed to purchase your spouse's interest in the investment property. You would also be entitled to a deduction for your portion of interest expenses incurred on funds borrowed to re-build the investment property. | Detailed Reasoning - Application of Part IVA: Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. In broad terms, Part IVA will apply where the following requirements are satisfied: · there is a scheme (see section 177A); · a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C); and · the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)). The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case. In your case, what you are proposing is a 'scheme' capable of attracting the operation of Part IVA. However, when considered in conjunction with the factors in paragraph 177D(b) of the ITAA 1936, all these factors either point against the application of Part IVA or are neutral. Therefore, Part IVA will not apply to this arrangement.

2. Are you entitled to a deduction for the interest incurred on funds borrowed to rebuild the rental property? | 3. Will Part IVA apply to the arrangement? | Your spouse purchased a property (property A) and used it as his/her main residence. | You married soon after and you, your spouse, and your children, lived in the property until 200X. | In 200X, you and your spouse purchased the property next door (property B) and that property then became your main residence. | Property A was then used as a rental property. | Your spouse is the sole owner of property A and property B is held in joint names. | Property A was rented out until 200Y when the tenants vacated the property. | Due to the state of the property at that time, it was originally decided that Property A would be demolished and a new home built in its place to be used as your new main residence. | You have now changed your mind and plan instead to sell property B and you will purchase a 50% interest in property A from your spouse at market value. | You plan to buy another property elsewhere, in joint names, to be used as your new main residence. | You plan to build a new investment property on property A, although no plans have yet been submitted to council. | You will borrow money to buy the 50% share in property A from your spouse.