Edited version of your written advice

Authorisation Number: 1051214211749

Date of Advice: 20 April 2017

Ruling

Subject: Holding costs for vacant land

Question

Are you entitled to a deduction for the interest and holding expenses incurred?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commenced on:

1 July 2014

Relevant facts

You purchased a block of land X years ago, with the intention to build a rental property as an investment.

You borrowed funds to assist with the purchase of the land.

At the time of buying the land, you had insufficient funds to build, and you had not formally applied for finance to do so

Over time you negotiated with builders and in Y years considered you were in a financial position to fund construction. You then found after enquiring with banking brokers and banks that you had insufficient deposit funds.

This was due to the regulatory authorities as well as the Reserve bank of Australia requiring the banks to demand a greater deposit for investment loans.

In 20XX you had funds compliant with regulatory requirements for a deposit, and you expect that you will build a rental dwelling on the land in 20YY.

You did not apply for finance to build in 20XX.

You do not wish to have failure to gain approval on your credit history, as it may have a negative effect on future applications.

You expect to apply once your partner has been re-employed for some months and has a regular wage history.

You have had a number of discussions with the relevant council.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Summary

The interest expenses and rates incurred in relation to the purchase of your land are deductible where the intention is to build a rental property and continuing efforts are made in relation to this. However when the decision was made to put a loan application on hold, continuing efforts to derive rental income are no longer present and the necessary connection between outgoings and assessable income is not present. Therefore no deductions for the interest and rates are allowable.

Reasoning

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.

Generally, interest expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances.

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith 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 interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income.

The Commissioner's view on whether interest deductions are allowable prior to the commencement of income earning activities and the implications of the decision of the High Court in Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele's case) are outlined in Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities.

In Steeles case, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. TR 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,

● the 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's case deals with the issue of interest, the principles can be applied to other types of holding expenditure such as rates.

TR 2004/4 states that, in considering the final of the above conditions, a test of 'continuing efforts' would need to be set within the context of the normal time frames of the relevant industry. However, if a venture becomes truly dormant and the holding of the asset is passive, relevant interest will not be deductible even if there is an intention to revive that venture sometime in the future.

Interest deductions in relation to the purchase of a block of land were also discussed in Temelli v. FC of T 97 ATC 4716; (1997) 36 ATR 417 (Temellis case). In this case it was found that there was not a sufficient connection between the interest paid and the prospective income producing activity for a deduction to be allowed. In Temellis case the taxpayers purchased a block of land with the intention of building a house for rental purposes. Three years later, they had not proceeded beyond having drawings and cost estimates prepared. In distinguishing the matter from the earlier decision of the Full Federal Court in Steele v. FC of T 97 ATC 4239 (Steele), the Court noted at 4243 that Steele had demonstrated the required commitment to the redevelopment of grazing land into a motel and townhouse complex. After purchasing the land, Steele had in fact obtained Councils assent to a zoning change, employed architects and engineers, entered into a joint venture arrangement and pursued the project with some tenacity until litigation with her collaborator put a complete stop to it. She demonstrated her commitment from the beginning by putting $1 million into the venture plus the time, energy and considerable expense of the subsequent architectural and engineering work and negotiations with the local council, sewerage authority and prospective joint venturers and financiers. The level of commitment demonstrated by Steele to the project was not an issue in the appeal to the High Court.

In Temellis case the Court found that the taxpayers had not made a decision to proceed with the building of a house on the land for a number of years. Their lacks of commitment to the project lead to the conclusion that the associated expenses were not an allowable deduction. It was found that the temporal gap left open the possibility of a non-income producing purpose to such an extent that the required nexus did not exist.

Following the guidelines in TR 2004/4, you are not entitled to a deduction for your interest and holding costs.

You made a decision not to proceed with loan applications as you had insufficient funds for this, or had not applied for finance.

We acknowledge that the APRA and lending authorities' requirement for a greater deposit for investment loans was beyond your control, however by not proceeding, you effectively put the project on hold, and the necessary connection between the interest and rates and assessable income is lost. Accordingly, you are not entitled to a deduction for the interest expenditure or rates you incurred in relation to your vacant land.

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