Private ruling: the deductibility of interest
Published: October 2013
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for your portion of the interest incurred on a loan for the period the funds were deposited into the offset account of your investment property loan? | A1: Yes. | Q2: Are you entitled to a deduction for your portion of the interest incurred on loan one, after the funds that were deposited offset account one are withdrawn? | A2: Yes.

Relevant facts and circumstances: You have two loans with a financial institution - loan one and loan two. Both loans are in yours and your spouse's names. Both loans have offset accounts - offset account one for loan one and offset account two for loan two. Both loans have the same variable interest rate. The loan is in the names of you and your spouse. You purchased an investment property with the funds from loan one. The funds from loan two were deposited into offset account one. However it should have been deposited into the offset account two. You deposited additional savings into offset account one, and withdrew a small number of small cash withdrawals for unknown use. The rent from the rental property is also paid into the offset account one. It is your intention to transfer the funds back into offset account two in the near future. You have not done so to date as you have been overseas, and you were waiting for the result of your private ruling application. You are not entitled to receive interest on the amounts held in the offset account one. However your lender allows you to offset the balance of offset account one against your loan one borrowings, to reduce the amount of interest charged. The interest on loan one is reduced up to the amount of interest which would have been charged on the loan amount equal to the balance of the offset account.

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

Reasons for decision: Summary: Section 8-1 of the Income Taxation Assessment Act 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. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset, the interest on this borrowing is considered to be incurred in the course of producing assessable income. Loan one and offset account one Taxation Ruling TR 93/6 outlines the Commissioner's view on interest 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 (offset account). It is accepted that where the offset account is a sub-account, it will be treated as a separate account § no interest is received on the offset account, and § the interest on the loan can only be reduced to the extent of the amount of interest which would have been charged on the loan amount, equal to the balance of the offset account. A taxpayer with an acceptable loan account offset arrangement is entitled to claim a deduction for the full 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 offset account and used for non-income producing purposes. Depositing funds into the offset account will decrease the interest payable on the loan account, but will not decrease the balance of the loan account. Withdrawing funds from the offset account will increase the interest payable on the loan account, but will not increase the balance of the loan account. In your situation, you have a loan (loan one) which funded the purchase of an income producing property. Loan one operates in conjunction with offset account one. Any credit balance of offset account one will reduce the interest payable on loan one. The amount of interest reduction will be the amount which would have been charged on the loan amount equal to the deposit before taking into account the offset. Consequently loan and offset account one is considered to be an acceptable loan offset arrangement and you are entitled to a deduction for the interest charged on loan one. This will remain the case where funds are withdrawn from the offset account one and used for either income or non-income producing purposes. Loan two funds deposited to offset account one When you deposited funds from loan two to offset account one, it is necessary to examine whether the deposit produces an amount of assessable income or benefit greater than or equal to the interest incurred on loan two. As the interest rates on loan two and loan one are equal, the benefit from depositing the funds into offset account one (reduced interest payable on loan one) is equal to the interest on loan two. As such, all interest incurred on loan two is considered a deductible expense for the period the funds were deposited to offset account one.