Interest Expenses - Rental Property Located in a Foreign Country

Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for interest expenses incurred from 1 July 2001 in relation to a foreign rental property?

Yes. The taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for interest expenses incurred from 1 July 2001 in relation to a foreign rental property.

The taxpayer is an Australian resident.

The taxpayer owns an overseas rental property.

The taxpayer borrowed money to fund the purchase of the rental property.

The taxpayer is assessable on the foreign rental income.

The interest expense on the loan exceeds the rental income from the rental property.

Section 8-1 of the ITAA 1997 allows a deduction for all losses or 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.

Paragraph 8-1(2)(d) of the ITAA 1997 provides that a deduction will not be allowed where another provision of the Income Tax Assessment Act 1936 (ITAA 1936) or the ITAA 1997 prevents it.

Section 79D of the ITAA 1936 provides that where a taxpayer incurs deductions in relation to a class of assessable foreign income, and the amount of those deductions exceeds the amount of foreign assessable income of that class, then the deductions allowed are limited to the amount of income received. Any excess deductions create a foreign loss which is not deductible against income of other classes or from domestic assessable income (ATOID 2002/177). This is referred to as foreign loss quarantining. Such quarantined foreign losses may be offset against income of the same class in a later income year.

For income years commencing on or after 1 July 2001, debt deductions are no longer subject to foreign loss quarantining. The definition of 'foreign income deduction', to which the foreign loss quarantining provisions apply, now excludes debt deductions to the extent they are not attributable to any overseas permanent establishment of the taxpayer (subsection 160AFD(9) of the ITAA 1936).

'Debt deductions' are, broadly, deductible costs incurred in obtaining and maintaining debt finance (section 820-40 of the ITAA 1997). Examples of debt deductions include interest, amounts in the nature of interest and fees, such as loan establishment fees and draw down fees, in respect of debt.

As debt deductions are no longer included in the definition of 'foreign income deduction' for income years commencing on or after 1 July 2001, the calculation of net foreign income (that is, foreign income less deductions) is no longer reduced by debt deductions to the extent that those debt deductions are not attributable to an overseas permanent establishment of the taxpayer.

The interest expense incurred by the taxpayer after 1 July 2001 is a debt deduction and the full amount is allowable as a deduction under section 8-1 of the ITAA 1997 against total assessable income of the taxpayer.