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Forward Thinking Magazine : April 2011
20 ExamPlE 1: ExamPlE 2: ExamPlE 2: aSSET non-incomE Producing BuT inTErEST dEducTiBlE: Mitch borrowed funds to purchase vacant land upon which he intended to build a house to let. After running into financial difficulties, construction was delayed by four years, during which Mitch continued to save for, and research, the building of the house. Ultimately the house was built and let to tenants. Interest incurred on the borrowed funds from the time of purchase of the land was deductible as Mitch continued to demonstrate his intention to use the land for income producing purposes. See Australian Taxation Office (ATO) Interpretative Decision 2001/307(W) and Private Ruling 62437. inTErEST noT dEducTiBlE aS incurrEd ‘Too Soon’: Like Mitch, Jean borrowed funds to purchase vacant land upon which she intended to build a house to let. Her intention was to hold the investment for five years and then review her situation. For financial reasons she delayed the commencement of building, and did not choose a building plan or engage a builder. Having regard to the whole of the circumstances, including Jean’s five year holding period intention, interest incurred on the borrowed funds from the time of purchase of the land was not deductible. The necessary connection between the interest expense and the assessable income was lost as the interest expense was incurred at a point ‘too soon’ before the commencement of the income producing activity. See Private Ruling 1011303472872. Interest deductibility and the borrower’s intention The first step in determining whether interest is deductible is generally to identify the purpose to which borrowings are applied when the interest expense is incurred – if applied to an income producing purpose then, in general, interest will be deductible. Income producing assets may include real property, listed securities, unlisted managed funds, etc. Where borrowings are initially applied to a non-income producing purpose, but subsequently applied to an income producing purpose, or vice versa, the timing of the interest expense will be important. Interest incurred during the period attributable to the non-income producing asset will generally be non-deductible. Income producing intentions Interest may, however, be deductible where the asset purchased is not yet, or has ceased to be, income producing. The borrower’s intention with respect to the income producing purpose of the asset (which is to be discerned from objective evidence) may be crucial in determining deductibility, as illustrated in the following examples.