Private ruling: Interest deductions on refinancing of loan
Published: April 2014
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: April 2014

Ruling: Q1: Are you entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for interest expenses on a refinanced loan used for income producing purposes? | A1: Yes

Relevant facts and circumstances: You participated in a managed investment scheme (MIS) covered by a product ruling. At a later date receivers were appointed to the project and it is being wound up. You obtained the money to participate in the project by taking out a loan from a lender associated with the project. You have continued to claim the interest payable on this loan as a tax deduction after the project went into receivership. Following the project going into receivership you did not receive sufficient proceeds to clear the outstanding balance of the loan. You wish to refinance the amounts currently outstanding on the loan as you are able to get a better interest rate from another finance provider. You propose to enter into a loan product with a bank. This loan has the following relevant features: • Borrowings are structured into a primary account and sub-accounts • Salary and income can be paid into the loan and then redrawn to pay expenses using a credit card. • Sub-accounts can be used to keep different finances separate. • Funds can be redistributed between sub-accounts as priorities change. • Interest rates and repayment options can vary between sub-accounts. The balances of the current loan will be placed in a separate sub-account so that amounts can be held separately and interest easily tracked. You intend to pay your income into the new loan product as described in the brochure and will redraw amounts from the primary account for personal expenses. You will not redraw from any sub-accounts. You will direct monthly payments to be allocated to the sub-account in payment of the refinanced loan. These will be lower than your previous payments because you will have a lower interest rate. You expect the loan to be repaid within the same or shorter time than the original loan term.

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

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, or relate to the earning of exempt income. Interest expenses are generally deductible under section 8-1 of the ITAA 1997 to the extent that they are incurred in relation to funds used for an income producing purpose. Interest deductions after business has ceased The Commissioner's view on whether interest deductions are allowable after the cessation of the relevant income producing activity is outlined in Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities. The ruling considers court decisions regarding deductibility of interest after businesses have ceased and explains that a determination of whether interest continues to be deductible requires a judgment about the nexus between the outgoing and the income earning activities. Paragraphs 12 and 13 of TR 2004/4 state: 12. An outgoing of interest in such circumstances will not fail to be deductible merely because: • the loan is not for a fixed term; • the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty; or • the original loan is refinanced, whether once or more than once. 13. However, if the taxpayer: • keeps the loan on foot for reasons unassociated with the former income earning activities; or • makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred, the nexus between the outgoings of interest and the relevant income earning activities will be broken. The ruling examines decisions in the decisions of the Full Federal Court in FC of T v. Brown 99 ATC 4600; (1999) 43 ATR 1 ( Brown ) and FC of T v. Jones 2002 ATC 4135; (2002) 49 ATR 188 ( Jones ). In both Brown and Jones, the interest in question was incurred at a time after the relevant income earning activities had ceased and borrowed funds (or assets representing those funds, including goodwill) had been lost to the taxpayer. The Court held, in both instances, that interest incurred on the loans continued to be deductible despite the cessation of the relevant income earning activities. This case is similar to those described in TR 2004/4 where interest expenses arise following the cessation of a business. The interest expenses continue to be deductible where the nexus between the interest expense and the former income earning activities is not changed. In considering whether interest will continue to be deductible in this case we must look at the particular proposal for refinancing. In a situation where one loan is refinanced by another loan and the amount financed remains the same (i.e. the closing balance of the first loan equals the opening balance of the new loan) interest will generally continue to be deductible. Interest may not continue to be fully deductible where there are changes to the loan circumstances, for example where: • the loan balance is increased where additional funds are borrowed for a different purpose (e.g. buying a family car) • the balance of the original loan is added to another existing loan (e.g. added to an existing home loan) • the new loan is a part of a line of credit facility where amounts paid into the loan are regularly withdrawn and used for other purposes. The deductibility of interest where there are mixed purposes is examined in TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities. TR 2000/2 states that, where a line of credit facility is divided into sub-accounts and each sub-account is used for a specific purpose, interest is fully deductible where funds drawn down on an investment sub-account continue to be used exclusively for an income producing purpose. Interest is not deductible where funds drawn down on a private sub-account are used for a non-income producing purpose. Where interest accrues periodically on the outstanding balance of a mixed purpose line of credit sub-account, the deductibility of accrued interest is determined by considering the application of the borrowed funds for income producing and non-income producing purposes. The original application of the borrowed funds will not determine deductibility where funds borrowed under a line of credit facility have been recouped or withdrawn from the original use and are reapplied to a new use (e.g. upon sale of an asset purchased with borrowed funds). Where a taxpayer has a mixed purpose sub-account, the interest needs to be apportioned (on a fair and reasonable basis) between the income producing and non-income producing purposes. While the ruling focuses on mixed purpose sub-accounts, the same principles apply to single line of credit accounts used for mixed purposes. The information provided regarding the proposed loan is similar to the line-of-credit loans described in TR 2000/2. The balance of the MIS loan will become the opening balance of a sub-account of your new loan. The taxpayer will not draw or re-draw any amount from that sub-account but will direct regular payments to the sub-account to allow the loan to be repaid within the same or a shorter period than the original loan term. Where used as described in the facts, the interest accruing on the loan will be deductible under section 8-1 of the ITAA 1997.