Private ruling: Deductions
Date of advice: 22 November 2017
Published: April 2018
Ruling period: 1 July 2017 to 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Does a loan have to be a commercial property loan for interest to be deductible under section 8-1 of the Income Tax Assessment Act 1997 ? | A1: No

Relevant facts and circumstances: XX and YY have a family partnership. The partnership includes two assets - a commercial property and a residential property. The partnership derives taxable rental income from the two properties. The properties are financed on an interest only basis. The type of loan the partnership current has is no longer available therefore the loan is coming to an end. The partners are considering their refinancing options.

Relevant legislative provisions: Section 92 of Income Tax Assessment Act 1936 | Section 8-1 of Income Tax Assessment Act 1997 | Section 995-1 of Income Tax Assessment Act 1997

Reasons for decision: Detailed Reasoning - Issue 1: Deductibility of loan interest | Detailed Reasoning - Question 1: Does a loan need to be a commercial property loan for interest to be deductible under section 8-1 of the Income Tax Assessment Act 1997? | Summary: A loan to refinance your income producing rental properties meets the criteria for interest to be deductible. Whether the loan is a commercial property loan or ordinary home loan is not a relevant consideration in the application of section 8-1 of ITAA 1997. | Detailed Reasoning - Partnership assets: The family partnership includes two assets, a commercial property and a residential property. The properties are currently financed by a loan. The taxpayers derive taxable rental income from both properties. | Detailed Reasoning - Tax deductibility: 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 (TR 95/25) discusses deductibility of a loss or outgoing comprising interest under section 8-1 of ITAA 1997. It states that deductibility depends on being able to show that the loss or outgoing is: a) incurred by the taxpayer in gaining or producing assessable income of the taxpayer and the loss or outgoing is not capital, or of a capital, private or domestic nature ('first limb'); or b) necessarily incurred by the taxpayer in carrying on a business for the purpose of gaining or producing assessable income of the taxpayer and the loss or outgoing is not capital, or of a capital, private or domestic nature ('second limb'). Section 8-1 of the ITAA 1997 allows a deduction from your assessable income for any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, you cannot deduct a loss or outgoing under this section to the extent that it is a loss or outgoing of capital, or of a capital nature; or of a private or domestic nature; or is incurred in relation to gaining or producing your exempt income. Several court decisions have determined that, for an expense to satisfy the tests in section 8-1 of the ITAA 1997: a) 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); b) 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); c) 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 (1971) 125 CLR 494) d) If the expense is incurred to gain a capital benefit or for a private purpose, then the expenses incurred take on the characteristic of being capital or private and are not linked to assessable income. The tests for assistance in resolving the characterisation between revenue and capital costs were established in Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337. The essential character of an outgoing is generally determined objectively. However, if an outgoing produces no assessable income or if the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure to determine whether the outgoing is wholly deductible. Taxation Ruling TR 95/33 Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings (TR 95/33) states that it may be necessary to examine your subjective purpose, motive or intention in making an outgoing. Therefore, for interest expenses to be deductible under section 8-1 of ITAA 1997 it must be an income producing expense and have sufficient nexus to assessable income. The partnership derives taxable rental income from the two properties. A loan to refinance your income producing rental properties meets the criteria for interest to be deductible under section 8-1 of the ITAA 1997. Whether the loan is a commercial property loan or ordinary home loan is not a relevant consideration in the application of section 8-1 of ITAA 1997.