As RobG said a while ago the ATO site is very broad. Endeavours need to continually be made towards the income producing objective otherwise the interest may not be deductible. As with any area of tax law nothing is ever simple and RobG highlights this in all his posts where he usually just responds with more questions. Not because he isn't trying to answer the questions but making the point that the small details are what these cases eventually turn on and they can make a huge difference to the outcome.
The following PBR provides some guidance for that particular matter which was considered by the applicant.
Authorisation Number: 1011631082184
This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.
Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.
Ruling
Subject: Interest expenses
Are you entitled to a deduction for the interest and holding costs incurred on your vacant land?
No.
This ruling applies for the following periods:
Year ended 30 June 2008
Year ended 30 June 2009
Year ended 30 June 2010
The scheme commences on:
1 July 2007
Relevant facts and circumstances
You purchased vacant land with the intention of building a rental property.
You took out an investment loan to purchase the land. You incurred interest on this loan.
You have no intentions of living in the area as you and your spouse work interstate but you may relocate to the area in the longer term.
You had made prior preliminary investigations when you arranged visits to the area and had discussions with builders and developers to consider house plans, costs and designs. You also attended a number of open houses in the area sourcing ideas.
You were concerned with the cost of building being almost double due to transportation costs of materials when comparing to some in your area.
You noted in discussions with builders the number of properties for sale and commercial development being on hold. You were informed that this was due to the global financial crisis. For these reasons you decided to wait and see. You had delayed building until you visited the area again in 2010.
You are now planning to make firm arrangements with a builder to commence construction. You are hopeful of having the home available for rent in the next income year at the current rental market rates.
You have yet to source real estate agents but you have been told of a high level of rental properties required in the area including the future mining development in the region that will provide further potential for rental properties.
You have made preliminary enquiries regarding finance to build. Once you have established costs to build you will finalise your loan to build.
You have provided copies of emails when you corresponded with builders for sourcing of building plans and arranging appointments with builders. .
Reasons for decision
Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature.
In Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele), the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. In considering the above decision, Taxation Ruling 2004/4 concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances:
- the interest is not incurred too soon, is not preliminary to the income earning activities, and is not a prelude to those activities
- the interest is not private or domestic
- the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost
- interest is incurred with one end in view, the gaining or producing of assessable income, and
- continuing efforts are undertaken in pursuit of that end.
While Steele deals with the issue of interest, the principles can be applied to other types of expenditure including local council, water and sewage rates, land taxes and emergency services levies.
However, in Temelli v. FC of T 97 ATC 4716; (1997) 36 ATR 417 (Temelli), it was found that the temporal hiatus left open the possibility of some purpose other than gaining or producing assessable income to such an extent that the required nexus did not exist. The interest did not have a sufficient connection with the prospective income producing activity of rental of the proposed residence. The taxpayers did not have the requisite degree of commitment to the income producing activity or the income producing element of the project. Through to the end of the year of income, the issue was whether, and if so when, a residence would be built for income earning purposes.
In your situation, the interest was incurred on borrowed funds used to acquire vacant land with the intention of constructing a house that would be solely used to produce income. There is no private or domestic purpose for holding the property and it was always your intention to build an income producing property.
Since purchasing your land you have made preliminary enquiries with builders in sourcing designs, house plans and looking at display homes. You had concerns about the number of properties for sale and the high cost of building in the area due to the global financial crisis. For these reasons you decided to wait and see what happened.
Your circumstances are similar to those of Temelli in that you only made preliminary enquiries with builders in sourcing designs and house plans. You are yet to finalise plans to build and to engage a builder. You have made no formal application for finance. Although you are now planning to make final arrangements with a builder to commence construction, up until 2010, continuing efforts had not been made in pursuit of that end.
The period of time between the purchase of the land and commencement of construction is considered to have been so long that the necessary connection between the interest and holding cost outgoings and assessable income is lost.
Therefore, you are not entitled to claim a deduction for interest or holding expenses relating to your vacant land for the 2007-08, 2008-09 and 2009-10 income years.
