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Is mortgage protection insurance for a bank loan used to purchase an income producing asset, deductible under section 25-25 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes, a deduction for mortgage protection insurance is allowable under section 25-25 of the ITAA 1997 as a cost of borrowing.

The taxpayer purchased an income producing asset financed by a bank loan. The bank loan is solely for the purpose of purchasing the asset and was taken out over a 10 year period.

As a condition of finance approval, the taxpayer was required to take out mortgage protection insurance by the bank at a cost exceeding $100. A once and for all payment for the mortgage protection insurance was made at the time the loan was taken out. The insurance policy protects the bank in case of default by the borrower.

A deduction is allowable under section 8-1 of the ITAA 1997 for expenses incurred in gaining or producing assessable income. However, the deduction is only allowable to the extent that it is not capital, private or domestic in nature.

Mortgage protection insurance protects the lender from loss in the event that the borrower defaults on the loan. In the situation where an insurance claim is made, the proceeds are applied to the loan. The insurance does not protect the taxpayer's capacity to earn income from the asset.

The mortgage protection insurance premium is a one off payment prior to the asset becoming income producing and is to protect the bank from loss. The payment bears no relationship to the gaining or producing of assessable income. The taxpayer is therefore not entitled to a deduction under section 8-1 of the ITAA 1997.

However, section 25-25 of the ITAA 1997 states that you can deduct expenditure you incur for borrowing money, such as mortgage insurance, to the extent that you use the borrowed money for the purpose of producing assessable income.

Borrowing costs not exceeding $100 are fully deductible in the year in which they are incurred.

If the total borrowing costs exceed $100, the deduction is spread over the period of the loan or 5 years - whichever is the shorter period.

Subsection 25-25(5) defines the period of the loan as the shortest of: (a) the period of the loan as specified in the original loan contract; or (b) the period starting on the first day on which the money was borrowed and ending on the day the loan is repaid; or (c) 5 years starting on the first day on which the money was borrowed.

The method for calculating the allowable deduction for each income year is contained in subsection 25-25(4) of the ITAA 1997.

As the mortgage protection insurance expense exceeded $100 and the loan was taken out for a 10 year period, the taxpayer is entitled to a deduction spread over 5 years for the cost of the insurance under section 25-25 of the ITAA 1997.