Private ruling: Interest expenses
Published: December 2012
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2011

Ruling: Q1: Are you entitled to a deduction for interest expenses incurred on loan money used to purchase income producing investments after the sale of these investments? | A1: Yes. | Q2: Are you entitled to a deduction for all interest expenses incurred on the loan money where some of the money was redrawn and used for private purposes? | A2: 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 ( Lunneys 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 ( Ronpibon's case) , 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). Generally, interest expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances. 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 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. TR 95/25 lists the following general principles to determine whether interest is deductible under section 8-1 ITAA 1997: · the interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be of a capital, private or domestic nature · the character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower · a tracing of the borrowed money which establishes that it has been applied to an income producing use may demonstrate the relevant connection between the interest and the income producing activity · interest on borrowed funds will not be deductible simply because it can be said to preserve assessable income producing assets, and · interest on borrowings will not continue to be deductible if the borrowed funds cease to be employed in the borrower's business or income producing activity. If the money is borrowed for the purpose of, or applied in, producing both assessable and non-assessable income, rather than producing only assessable income, the interest expense may need to be apportioned (see Ronpibon's case at 59; 8 ATD 431 at 437; Kidston Goldmines Ltd v. FC of T 91 ATC 4538 at 4544-46; (1991) 22 ATR 168 at 175-177). In your case, your borrowed funds were used to purchase income producing investments. However, after selling many of the investments, you still have an outstanding amount on your loan. 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. Paragraph 10 of TR 2004/4 states that where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and the relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing the assessable income if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period. Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgement about the nexus between the outgoing and the income earning activities. As your borrowed funds were used to produce assessable income while you held the investments, it is considered that the funds were used for income producing purposes. As the investments are regarded as being an income earning activity, the principles of TR 2004/4 apply. It is considered that the income producing portion of your loan is sufficiently connected to your prior income earning activity after the sale of your investments. Redrawn funds Taxation Ruling TR 2000/2 considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities. The ruling establishes drawing any excess or available funds from the loan is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put. Where a person uses the redrawn funds for different purposes then the loan account becomes a mixed purpose account. In a mixed purpose loan, the interest must be apportioned between the income producing and non-income producing purposes. The part of the accrued interest attributable to the funds used for private purposes is not deductible. In your case you redrew some of the available funds from the loan for private purposes. The previous repayment of funds into your loan account represented a repayment of the loan debt. As the debt owing on your loan was reduced, the future redraws on the loan are considered to be a new loan. Therefore, as the redrawn amounts were not used for any income producing purpose, no deduction is allowable for the associated interest. This remains the case even though a similar amount is later deposited into the loan to reduce the outstanding balance. It is acknowledged that it was an error in not having an offset account in place. However, this does not change the use of the redrawn funds. The above principles are still relevant. Please note that interest on a new loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing. However where the previous loan has a dual purpose, the new loan will also have a dual purpose. That is, when your loan was refinanced, the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities. In your case, at the time of your refinancing, you deposited funds into your loan account. This does not reduce the private portion of your loan. A repayment to a mixed purpose loan can not be directed to the private portion only. As the redrawn amount is considered to be private in nature, a deduction for the interest incurred would not be deductible under section 8-1 of the ITAA 1997. That is, interest expenses on the private portion of the loan is not an allowable deduction. Therefore you need to apportion your interest expense between the income producing purposes and the non income producing purposes. Please note that as a joint owner of the investments, you are only entitled to a deduction of 50% of the allowable expenses.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Relevant facts: A few years ago, you and your spouse sought investment advice from financial planners for retirement planning as you were advised that you would not have sufficient funds in retirement. | Following the investment advice, your home equity was used to increase your investment portfolio by increasing your level of gearing. | Some money from loan one was withdrawn for personal use. | Two years later you were advised to further increase your level of borrowing. Following this advice the margin loan was increased. | You derived assessable income from your investment portfolio. | As a result of the severe impact of the global financial crisis, investments were sold and proceeds were used to reduce the margin loan. Capital losses were made on these investments. | You have registered a complaint in respect of the advice received. | You are currently negotiating with regards to possible compensation which would be used to pay down the investment loan if received. | You are contemplating selling all the investments to pay down the loan as much as possible. This will still leave a large shortfall which you will strive to repay as soon as possible. Any remaining balance at retirement will be repaid by drawing on your superannuation funds. | In an effort to minimise the costs, you have restructured your investment loans with another bank which enabled repayment of the previous loans. This provided immediate savings on the interest rates. | Being keen to repay the loan as soon as possible, you have been depositing funds budgeted for later withdrawal into the loan account on the understanding that they could redraw these additional payments when required. The intention was to operate an offset account so that they could deposit funds to the loan temporarily to reduce the interest expense. However you ended up making all repayments to the redraw facility instead of a separate offset account. This error has now been rectified by using the Mortgage Interest Saver Account for depositing additional funds that they may need to redraw. During the 12 month period before the offset account was set up, you redrew some funds for personal use. | You deposited an amount into the new loan account prior to drawdown. This amount approximately equalled the amount of non-deductible amounts previously withdrawn. | You hope to have the loan paid off over the next five years.