By Gilda Brisotto

The Australian Taxation Office have warned that they are reviewing investment arrangements. There are two that they are especially concerned about:

Investment Loan Interest Payment Arrangement

The Commissioner of Taxation recently issued a Tax Determination (known as TD 2012/1) in relation to split loan structures described as “investment loan interest payment” arrangements.

The arrangement described in the Determination comprises: • a home loan; • an investment loan; and • a line of credit loan that funds the interest on the investment loan.

No cash is required from the borrower to pay interest on the investment loan because the interest is paid from the line of credit. The line of credit has no monthly repayment obligation.

The result of the arrangement is that interest is capitalised on the line of credit (which gets larger every year) and the borrower applies the cash saved to reduce the home loan faster. The borrower then also claims the interest on the line of credit account.

The ATO rejects the claims by borrowers that these arrangements are entered into for the purpose of paying their home loan sooner.

According to the ATO, borrowers would otherwise pay interest on the investment loan out of their cashflow rather than using the line of credit and that means they would have lower interest deductions if it were not for the arrangement.

On that basis, the tax office may disallow: • the whole amount of the deduction for interest incurred on the line of credit; or • the difference between the otherwise allowable deduction for interest on the line of credit and the amount of interest on the line of credit that would have been an allowable deduction if the arrangement had not been carried out.

Home loan unit trust arrangement

The Tax Office have released warnings reminding taxpayers of a Tax Ruling released in 2002 (TR 2002/D2) dealing with schemes where taxpayers purchase a residential property for private use through a unit trust.

A typical “Home Loan Unit Trust Arrangement” involves: • the taxpayer establishing a unit trust whereby they are the trustee or a director of the corporate trustee; • the taxpayer borrowing funds to purchase units in the unit trust; • the trust purchasing the property using the funds raised to complete the purchase; • the taxpayer then living in the property and paying rent to the unit trust at market rates which the trust declares as taxable income; • The trust then claiming associated expenses and interest charges as deductions against the rental income; • The taxpayer claiming a tax deduction for the interest payments on the borrowing. This is a scheme because it involves getting a tax benefit from borrowings for private expenses – the family home. The ATO claims that in such arrangements the interest is not deductible to the taxpayer as it is a loss or outgoing of a private nature. Furthermore, the ATO regards the arrangement as a tax-avoidance scheme whereby it will then apply Part IVA to deny the taxpayer the ability to claim a tax deduction for the interest on borrowing.

Please Note – The arrangement being targeted should not be confused with an arrangement which is allowed by the Tax Office which involves a genuine investment asset under which borrowing to invest in a unit trust would normally be tax deductible.