Private ruling: Deduction of interest expense
Published: May 2012
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 2011

Ruling: Q1: Can you claim a deduction for interest expenses? | A1: No

Relevant facts and circumstances: You had run a business from Year A until it was sold in Year B. In Year A you took out a business loan to acquire the business and to use for working capital. You used your residence as collateral which was otherwise unencumbered. When you sold your business you were left with the business loan of a size similar to the original amount borrowed. In Year C you sold your residence and used the funds to terminate the outstanding business loan. Within a few days you negotiated a new loan with a new bank to acquire a new residence and you were able to get a more favourable interest rate. The amount of the new loan was similar to the amount of the business loan.

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. 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 to which the borrowed funds have been put is used to determine the deductibility of the interest expense. ( FC of T v. Roberts; FC of T v. Smith 92 ATC 4380; (1992) 23 ATR 494, ATC at 4388; ATR at 504). 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. Interest on borrowings will not continue to be deductible if the borrowed funds cease to be employed in the income producing activity. In your case, the original loan were entered into to acquire income-producing assets and not for any other purpose. The funds were used to purchase a business which produced income. Furthermore, an obligation was undertaken to pay interest until the principal was repaid. Following the sale of the business you did not repay the loan. When you sold your residence you repaid the loan from the proceeds of the sale. You entered into a new loan agreement with a new bank to allow you to purchase a new residence. The issue, therefore is did paying out the loan sever the connection between the incurring of the interest expenses and your previous income producing activity. The repayment of the loan extinguishes this nexus as the terms and conditions of the original loan had been fulfilled and your ongoing obligation to the bank had ceased. You entered into a new loan agreement with a new bank to obtain funds for a purpose that was not connect to the income producing activity of the original loan. Your new loan is of a private nature as the funds were used to purchase a residence for yourself. As the original loan has been completed, no deduction is available for the interest paid on the new loan.

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