ATO Interpretative Decision
ATO ID 2006/298
Income Tax
Deductibility of compound interest on a line of credit facilityFOI status: may be released
CAUTION: This is an edited and summarised record of a Tax Office decision. This record is not published as a form of advice. It is being made available for your inspection to meet FOI requirements, because it may be used by an officer in making another decision.
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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for compound interest incurred on funds borrowed, under a line of credit facility, to acquire an income producing asset?
Decision
Yes. The taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for compound interest incurred on funds borrowed, under a line of credit facility, to acquire an income producing asset.
Facts
The taxpayer took out a line of credit facility, with a financial institution, which was divided into two sub-accounts.
One sub-account was used to acquire an income producing asset (investment sub-account) and the other sub-account was used for non-income producing purposes (private sub-account).
There were no fixed minimum principal and interest repayments required by the lender.
The taxpayer made no payments off the investment sub-account until the private sub-account had been repaid in full.
As interest was capitalised on the investment sub-account, compound interest, being interest on the capitalised interest, accrued on the investment sub-account.
Reasons for Decision
Section 8-1 of the ITAA 1997 allows a deduction for any loss or outgoing that is incurred in gaining or producing assessable income to the extent that it is not of a private, capital or domestic nature.
The deductibility of an outgoing is determined by its essential character ( Lunney & Hayley v. Federal Commissioner of Taxation (1958) 100 CLR 478; (1958) 11 ATD 404; (1958) 7 AITR 166).
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, Kidston Goldmines Limited v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168).
It is therefore generally accepted that ordinary interest incurred on funds borrowed to acquire an income producing asset is an allowable deduction.
In Hart v. Federal Commissioner of Taxation (2002) 121 FCR 206; 2002 ATC 4608; (2002) 50 ATR 369 it was held that compound interest, as with ordinary interest, derives its character from the use of the original borrowings.
In this case compound interest was incurred on funds borrowed, under a line of credit facility, to acquire an income producing asset. As such, the compound interest was incurred in earning assessable income and is an allowable deduction under section 8-1 of the ITAA 1997.
Note: While the general anti avoidance provisions of Part IVA of the Income Tax Assessment Act 1936 are not considered applicable in this case, the application of Part IVA depends on a detailed analysis of the facts of each case. The Commissioner considers that a scheme in relation to a loan facility would need to have the same features as those set out in paragraphs 16 to 19 in Taxation Ruling TR 98/22 before Part IVA could be applied.
Date of decision: 5 October 2006
Year of income: Year ended 30 June 2006
Legislative References:
Income Tax Assessment Act 1936
Part IVAIncome Tax Assessment Act 1997
section 8-1Case References:
Fletcher & Ors v. Federal Commissioner of Taxation
(1991) 173 CLR 1
91 ATC 4950Hart v. Federal Commissioner of Taxation
(2002) 121 FCR 206
2002 ATC 4608Kidston Goldmines Limited v. Federal Commissioner of Taxation
(1991) 30 FCR 77
91 ATC 4538Lunney & Hayley v. Federal Commissioner of Taxation
100 CLR 478
(1958) 11 ATD 404
(1958) 7 AITR 166Related Public Rulings (including Determinations)
Taxation Ruling TR 98/22
Taxation Ruling TR 2000/2
Taxation Determination TD 1999/42Keywords
Borrowings & loans
Deductions & expenses
Interest expenses
Part IVADate of publication: 27 October 2006
ISSN: 1445-2782
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Simon Macks
Residential and Commercial Finance Broker
[email protected]
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
Hi Simon,
It’s all well for learning from the case studies. As a general sweeping statement – the compound or capitalisation of interest is allowed, if there is evidence in subtantiating the purpose test for property (or any other business) investing (using LOC) to generate income.
But is it allowed to generate loss as a result to claim negative gearing benefits(where the income is siphoned to payoff personal debt)? This makes the threshold compliance line blurred.
Can you help clarify that, Simon?
CT
CT you would have to talk to your lawyer about that.
Terryw
Discover Home Loans
Parramatta
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Hello CT
I can’t find the post but if I remember correctly, not so long ago someone posted that there has been a ruling from the ATO that you can not use income from an IP to reduce personal debt instead of paying off loan against an IP and still claim full tax deduction of interest for that loan. In other words you first have to use the income from the IP to offset the expenses.
Correct me someone please it I am wrong.
Cheers [smiling]
ElkaHi Terry,
Why do I need a lawyer for ? [blink]
I haven’t done anything remotely like those cunning devils the case studies; although I’m certainly jealous [jealous] for those in the know who dared to test the unchartered waters to create inconspicuous wealth.
I suppose the lawyers cost them enough to fight their cases in the end.., and I for one, am not able to stomach the worries to live a normal life waiting for the outcome of ATO decision, however favourable the scheme is.
CT
Hi elkam,
Thanks for your input; that’s more like what I thought it feasible. Otherwise it’s a blatant miuse of the ruling and spelled tax avoiding scheme no matter how one looks at it.
Anyway, there are people doing just that and have deep pockets to defend their stakes… The penalties may be slap on the wrists to them, but too much to bear for us new straight investors.
CT
Hi
Take care as the ATO has very quickly withdrawn this ruling.
When I read the ruling it was quickly pretty obvious some pinhead in there issued this ruling without doing any research. This issue has clearly been dealt with by case law.
When these sort of conflicting ruling come out it doesn’t suprise me of the resulting confusion and anger from taxpayers. The ruling system goes against the separation of powers doctrine and is effectively individuals in the ATO creating tax law by what is effectively a press release.
Tony
It is interesting the ATO has not withdraw another similar ID issued close of the other one:
ATO ID 2006/297
Income Tax
Deductibility of compound interest» on a split loan facility
http://law.ato.gov.au/atolaw/view.htm?rank=find&criteria=AND~interest~basic~exact&target=JA&style=html&sdocid=AID/AID2006297/00001&recStart=881&PiT=99991231235958&recnum=892&tot=901&pn=ALL:::JABut that is probably because they will not allow it! :
“Decision
Yes. The taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for compound «interest» incurred on funds borrowed, under a split loan facility, to acquire an income producing asset. The Commissioner, however, will exercise his discretion under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to disallow the deduction otherwise allowable. “ATO ID 2006/298 (Withdrawn)
Income Tax
Deductibility of compound interest» on a line of credit facility
http://law.ato.gov.au/atolaw/view.htm?rank=find&criteria=AND~interest~basic~exact&target=JA&style=html&sdocid=AID/AID2006298/00001&recStart=881&PiT=99991231235958&recnum=893&tot=901&pn=ALL:::JATerryw
Discover Home Loans
Parramatta
[email protected]
Sign up to my mailing list.
Just send me a blank email, with “subscribe†in subject line.Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
I read the article ‘In Your Best Interest’ in the October issue of API. It was almost cut and dry in attempting to answer the interest deductibility concerns we have as investors. I quote the following pointers:
1. No change on deductibility of interest, for that matter, interest on interest. (It was implied that normal business with overdraft facilities already have capitalised interest and do not run into problems with tax deductibility.)
2. Obviously, loans marketed for thier tax benefits are out but on the other hand, investors are not obliged to pay more tax than necessary.
3. There is no problem in taking into account the deductibility of interest in negotiating the terms of loan (eg. IO loan for investment and P&I loan for PPOR)
4. The problem arises when the loans are not stand alone and are linked.
5. The more simple and normal the arrangement of loans the less likely it is to be considered a scheme.
6. ATO cannot tell investors how to run their affairs. But a systematic approach to increasing the loan on IP may point towards a scheme.
7. Watch out for spare funds to make extra payment on PPOR. A good way is to use Mortgage Offset account rather than straight into Home loan Redraw facility.
8. Do not be tempted prop up IP loan strategically.
I hope I do the article justice.
CT
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