Private ruling: Interest expenses
Date of advice: 7 September 2016
Published: November 2016
Ruling period: Year ending 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Question and answer | Where funds are deposited into an offset account and withdrawn for private purposes, are you entitled to a deduction for the interest where the loan is for a rental property? | Yes.

Relevant facts and circumstances: You have a loan for a rental property which has an offset account attached to the loan. You will deposit an amount into the offset account. You will draw on the funds in the offset account for private purposes.

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

Reasons for decision: Summary: Interest expenses 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 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, it is necessary to examine 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 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. However, where a loan relates to a private purpose, no deduction is allowed. In your case you have a loan for a rental property. You are entitled to a deduction for the interest expenses. Mortgage offset account Taxation Ruling TR 93/6 outlines the Commissioner's view on loan account 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. It is accepted that where the deposit account is a sub-account, it will be treated as a separate account. • No interest is received on the deposit account. • The reduction of the loan account interest should be achieved by offsetting the balances of the two accounts. A person with an acceptable loan account offset arrangement with dual accounts is entitled to claim a deduction for the reduced 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 deposit account and used for non-income producing purposes. Depositing funds into the deposit account will decrease the interest payable on the loan account but will not decrease the balance of the loan account. Withdrawing funds from the deposit account will increase the interest payable on the loan account but will not increase the balance of the loan account. In your case, you have a loan offset arrangement that is regarded as an acceptable loan account offset arrangement. Your loan accounts will operate in conjunction with your deposit accounts. Any credit balance of your deposit account will reduce the interest payable on your loan account. Consequently where you deposit funds into the deposit account, this does not reduce the principle on your loan. You will be entitled to a deduction for the interest charged on your loan account as the loan is for income producing purposes. Any funds withdrawn from your offset account for private purposes will not affect the deductibility of the interest on your loan.