Private ruling: Holding costs
Published: September 2013
Ruling period: Year ended 30 June 2009 | Year ended 30 June 2010 | Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: 1 July 2008

Ruling: Q1: Are you entitled to a deduction for the holding costs incurred on the assets used for security for your loan? | A1: No.


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. A number of significant court decisions have determined that for an expense to be an allowable deduction: § 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 ( Lunney's case )), § 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), and § 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 , 71 ATC 4184). The essential character of an expense is a question of fact to be determined by reference to all the circumstances. It is a long standing principle that a person does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some causal connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred "in the course of" gaining or producing the assessable income ( Lunney's case ). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3 . Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, regard must be given to all the circumstances including the purpose of the borrowing and the use to which the borrowed funds are put. The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 ( Munro's case ) is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income. Taxation Determination TD 93/13 considers the deductibility of interest on a loan used to acquire an income producing property where a non-income producing property (for example, the family home) is used as security for the loan. This determination provides that the deductibility of interest is determined by the use of the borrowed money and not by the security given for the borrowed money. Although the above relates to interest expenses, the principles are relevant in your circumstances. Whilst the interest expenses on your loan are an allowable deduction where the borrowed funds are used to purchase income producing assets, this can not be extended to the non-income producing assets held for security. It is acknowledged that assets are held for security and reduce the interest expenses incurred and allow you to purchase additional income producing assets, however the holding costs incurred in relation to these assets are not directly incurred to derive your assessable income. That is, there is insufficient nexus between your holding expenses and the derivation of your assessable income. Consequently no deduction is allowable for the holding costs under section 8-1 of the ITAA 1997.

Relevant facts: You have some non-income producing assets which you retain for the sole purpose of receiving discounted interest when it is used for security for your loan. | The security provided results in a reduction in the interest charged on the loan. | The loan funds are used to purchase income producing assets. Your income producing assets generate a higher income stream than it would without the security. | You incur holding costs for the non-income producing assets held as security.