Taxation Law: Interest, Borrowing Expenses, and Rental Property

This taxation law report addresses the issue of deductibility of borrowing expenses and interest against rental income, particularly in the context of a divorce settlement. The report analyzes the relevant laws, including "sec 8-1, ITAA 1997", and explains how the ATO views property settlements and related borrowing expenses. Part A of the report focuses on the legal issues and application of the law to a case involving a couple, Alfred and Rose, who are divorcing and have a jointly-held rental property. The report concludes that Alfred cannot deduct the interest and borrowing expenses incurred to pay out Rose's share of the property. Part B provides a letter of advice to Alfred, summarizing the legal principles and advising him on the non-deductibility of the expenses. The report emphasizes that borrowing expenses related to property settlements are considered private and not deductible for tax purposes. The report is well-structured, including an introduction, legal analysis, application of the law to the case, and a conclusion, along with a letter of advice and a list of references.

Running head: TAXATION LAW
Taxation Law
Name of the Student
Name of the University
Authors Note
Course ID

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Table of Contents
Part A:........................................................................................................................................2
Part B:.........................................................................................................................................6
References:.................................................................................................................................9

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Part A:
Issues:
The present issue is concerned with the deductibility of the borrowings expenses and
deduction of interest against the rental income.
Laws:
When the settlement in divorce happens due to the breakdown of the relationship it is
usually not treated as taxable. However, there are issues associated with the deductibility of
the interest after the breakdown of relationship when the settlement relating to property
happens. When there is a change in hands of property and the loans taken out to pay the ex-
spouse interest, then the interest on loan that is occurred is not permitted for deduction1. This
is because the ATO considers the settlement of property as personal or private settlement and
any kind of borrowings associated to the property settlement is not considered as related to
property. Rather the borrowings for settlement is regarded as the private spending and not
permitted as an allowable deduction under “sec 8-1, ITAA 1997”.
When the partnership in the asset is dissolved then the interest of the individual
taxpayer in the assets are commonly allocated among them. The interest that is present in the
partnership assets would normally be held as the jointly among the partners to a partnership,
in a similar way the matrimonial home between the husband and the wife is also considered
as jointly held between them.
1 Barkoczy, Stephen. "Foundations of taxation law 2016." OUP Catalogue (2016).

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The basic rules relating to the tax is that tax deductions are available under “sec 8-1,
ITAA 1997” only for those expenses that relates to the derivation of income2. A deduction for
interest is generally effected by the below given factors. These are as follows;
a. Interest should have to be occurred in relation with the production of income or
income generating activities of the taxpayer.
b. The character of interest is commonly ascertained based on the use to which the
borrowed funds is put into3.
c. The interest occurred for taking up a new loan is allowed for deduction if the new
loan is put into the use for repaying the existing loan interest and the second loan is
used in generation of chargeable earnings.
As evident, interest that is occurred on borrowings under the common law partnership
is usually allowed for deduction if it is used for funding the repayment of money that was
originally advanced by the partner or employed in the partnership as capital and was used in
the generation of revenue.
Denoting the decision made in “Commissioner of Taxation v Hart (2004)” the ATO
simply disallowed the deductions for interest taken for split or linked loan as it was a private
loan that was taken by the taxpayer to finance home4. The interest payments were applied
against the private loan which leaves the taxpayer from claiming the compound interest
deductions on the loan taken by the taxpayer. The loan interest that was occurred by the
taxpayer was not in relation to the production of income.
2 Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2016. Australian Taxation Law 2016. OUP Catalogue.
3 Murray, Ian, et al. "Understanding Taxation Law 2019." (2018).
4 Morgan, Annette, Colleen Mortimer, and Dale Pinto. A practical introduction to Australian taxation law 2018. Oxford
University Press, 2018.

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Application:
The evidences that is obtained from the current case shows that Rose and Alfred are
divorcing. The taxpayer here only had one jointly-held asset and it was their rental property.
However, Alfred took out loan to fund the pay-out of Rose interest in the property. As a
result, Alfred incurred interest and borrowing expenses in relation to the interest on loan.
The interest on loan and borrowing expenses that are occurred by Alfred to pay out
the shares of Rose will not be permitted as a permissible deduction under the legislation of
“sec 8-1, ITAA 97”. The interest on loan and borrowing expenses is should be considered as
property settlement between the taxpayer due to the breakdown in relationship5. The
settlement of property between the taxpayer is observed as the personal matter and the
borrowing expenses along with the interest on loan in regard to the property settlement is not
related to the borrowings for property. Instead the settlement will be viewed as the private
outlay and no permissible deduction will be allowed to Alfred.
Alfred should denote that a deduction for interest on borrowed funds and interest on
loan is allowed when the taxpayer uses the fund to produce business income. Furthermore,
the interest on borrowed funds and the borrowing expenses does not have adequate
connection with the income generating operations6. These expenses are termed as persona in
character and it is not allowed for income tax deduction under “sec 8-1, ITAA 1997”.
Conclusion:
5 Sadiq, Kerrie. Australian Taxation Law Cases 2019. Thomson Reuters, 2019.
6 Morgan, Annette, and Donovan Castelyn. "Taxation Education in Secondary Schools." J. Australasian Tax Tchrs. Ass'n 13
(2018): 307.

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On a conclusive note, it can be stated that the property settlement between Alfred and
Rose is regarded as the private matter and borrowing expenses together with interest on loan
in respect to settlement cannot be termed as related to borrowing for property.

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Part B:
Letter of Advice: Private and Confidential
Mr Alfred
Knight Mare Pty Ltd
21 Suleiman Drive
Yankees Delights NSW 9999
Date: 29-9-2019
Dear Alfred
Please find our letter of advice based on the discussion with you regarding the
deductibility of the interest expenses and borrowing expenses that you have occurred for
taking up the loan to pay out your ex-spouse from the jointly held rental property.
Scope of the advice:
The scope involves providing the advice to Mr Alfred regarding the claim for
deduction of outgoings against the rental income.
Facts of the letter:
The necessary facts that is considered is built on the information that is provided by
Mr Alfred. At any point if you find our advice not appropriate or not in conformity with the
information sought by you then you are allowed to contact us straightaway as this may have
adverse consequences on the information that is enclosed.
Summary of the Advice:

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We would like to make you aware that an individual taxpayer is simply permitted to
be entitled for tax deduction for those outgoings that are experienced at the time of gaining
the assessable earnings. The outgoings should be necessary occurred by the taxpayer during
the ordinary business course or with the purpose of making revenue. The dilemma associated
to the deductibility of interest or borrowing outgoings and divorce involves in depth
understanding. There are issues when marriages breaks down and assets held between the
partners are either distributed or sold in their respective shares. However, it is noteworthy to
denote that there could be issues associated with the deductibility of the interest and
borrowing costs that are occurred when the relationship or marriages breaks down, especially
when the assets involve the property settlement.
We would further like to make you aware that when there is a change of hands takes
place under the property settlement and loans that are taken out by the taxpayers to pay the
ex-spouse, the interest on loans and the borrowing expenses on those will not be allowed for
deduction against the rental income. This is because the ATO considers the matters relating
to the property settlement as the private matter. Where a taxpayer is found to have borrowed
money in respect to the settlement of property, the borrowings cannot be deemed as related to
the property. This is because borrowings for settlement between the ex-partners is regarded as
the private expenditure.
With respect to the information that has been furnished by you, we have seen that a
loan of $300,000 was taken by you to pay the share of your ex-spouse Rose. While Rose was
paid out her share of $300,000 as the property settlement. It can be stated that the Alfred you
cannot claim the interest and borrowing expenses against your rental income that you have
occurred in settling the property with Rose. The reason being cited in response to your case is
that, the borrowing expenses and interest is purely a private arrangement between you and
your ex-spouse. The borrowing in relation to the rental property settlement will not be

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deemed as borrowings associated to the property but borrowings associated to the private
expense settlement. The outlays were not incurred by you in making of your chargeable
earnings from the property nor do the expenses originate at the time of production of your
rental property income. Consequently, you will be denied deduction within “sec 8-1, ITAA
1997”.
Accordingly, after reading our response and advice please feel to let us know your
response in this regard. If you are also wishing further to discuss about this matter you are
also welcome and please feel to contact us at our registered office within our working hours.
We hope that the advice which we have given has been supportive in serving your
purpose and we look forward to hear from you soon.
Yours Sincerely
Associate Taxation
Knight Mare Pty Ltd

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References:
Barkoczy, Stephen. "Foundations of taxation law 2016." OUP Catalogue (2016).
Morgan, Annette, and Donovan Castelyn. "Taxation Education in Secondary Schools." J.
Australasian Tax Tchrs. Ass'n 13 (2018): 307.
Morgan, Annette, Colleen Mortimer, and Dale Pinto. A practical introduction to Australian
taxation law 2018. Oxford University Press, 2018.
Murray, Ian, et al. "Understanding Taxation Law 2019." (2018).
Sadiq, Kerrie. Australian Taxation Law Cases 2019. Thomson Reuters, 2019.
Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2016. Australian Taxation
Law 2016. OUP Catalogue.