Private ruling: Loan interest
Published: October 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to claim the interest on a loan used to pay off a debt? | A1: No.

Relevant facts and circumstances: You were living in your own home, your name was on the title deed and you had a loan for the property in your own name. A relative paid out the loan on your home, which meant that the debt was extinguished on your property. This occurred before you made your home available for rent. You received the title deed in your name. The loan your relative took out to pay for your property was attached to the debt already owing on their own principal place of residence. This effectively increased the debt on their own residence to include the balance of the debt which had been attached to your own home, but now was transferred to their own residence. You became the guarantor for the new loan taken out by your relative, and the loan was secured against their own property, and is in their name. You agreed with your relative that you would take responsibility for the part of the loan relating to the purchase of your home. You then rented out your property and moved in with your relative. For personal reasons, you later took out a loan in your name to repay the portion of your relative's loan which for which you had agreed to take responsibility. The purpose of the loan you have taken out is to repay the loan which is in your relative's name. Your property is used as security for the new loan in your name, but the loan it is repaying is attached to your relative's home.

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

Reasons for decision: Summary: Interest expenses incurred on borrowed funds that are used for income producing purposes fall for consideration under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997). Section 8-1 of the 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. The deductibility of an outgoing is determined by its essential character: Lunney v. Federal Commissioner of Taxation [1958] ALR 225;1958 - 0311H - HCA;100 CLR 478;(1958) 11 ATD 404;(1958) 32 ALJR 139. The character of interest is determined by the purpose of the borrowing. Generally, the purpose of a borrowing can be determined from the use of borrowed funds, and outgoings of interest ordinarily draw their character from that use: Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 ( Fletchers Case ); Kidston Goldmines Limited v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168. Interest incurred on funds borrowed to acquire an income-producing asset is an allowable deduction. Where an original borrowing is refinanced, the new loan takes on the same characteristics as the original borrowing. If a deductible borrowing is refinanced, the interest on the new loan will generally be deductible. In your case, the original loan you had was taken out to purchase the home that you were living in. This loan was not used to acquire an income producing asset and because of this, there was no deduction available for interest paid on the loan. This loan was finalised at the point that your relative paid it out to the lending authority, and then took the debt and attached it to the debt already owing against their own home, and as such there was no income producing purpose to the debt. When you subsequently decided to rent out your home, you owned it in full, and there was no debt attached to it. Even though your property is used as security against the amount you have borrowed to repay your relative, the connection between an income producing purpose and the debt has been lost, as you cannot borrow to buy an asset that you already own. The loan that you currently have with your lending authority is used to repay a debt to your relative, and is used to repay the loan on their own property. This is different to the loan you originally had on your property. That loan was finalised at the time your relative paid it out. The new loan you have is for the purpose of paying off the monies owed to your relative, as such is not for an income producing purpose. Therefore, the interest you pay on this current loan is not allowed as a deduction under section 8-1 of the ITAA 1997.

You cannot rely on the rulings in the Register of private binding rulings in your tax affairs. You can only rely on a private ruling that we have given to you or to someone acting on your behalf. | The Register of private binding rulings is a public record of private rulings issued by the ATO. The register is an historical record of rulings, and we do not update it to reflect changes in the law or our policies. | The rulings in the register have been edited and may not contain all the factual details relevant to each decision. Do not use the register to predict ATO policy or decisions.