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WEALTH MAXIMISER UPDATE - FEBRUARY 2008 |
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Wealth Maximiser Update 12th February 2008 - We have advice from the ATO that it is well advanced on a binding Tax Determination regarding the deductibility of capitalised interest on a line of credit facility.
Borrowers with both a home loan and an investment loan should consider including a capitalising line of credit within their loan structure or at least ascertaining from their lender that they could access such a facility by way of a simple variation of their existing mortgage.
Wealth Maximiser Update February 2008
Deductibility of capitalised interest under s 8-1 of ITAA 1997
Background
In December 2006 the ATO released ATO ID 2006/298 Income Tax: Deductibility of compound interest on a line of credit facility. The facts of the case as published in the ATO ID related to a taxpayer who had taken out a line of credit facility, divided it into 2 sub-accounts, one being for private use, the other for investment. No fixed minimum principal and interest repayments were required by the lender provided the overall loan limit was not exceeded. The taxpayer made no payments to the investment account until the private sub-account had been repaid. Interest capitalised on the investment account with compound interest (being interest on interest) accruing on the investment account.
The ATO ID determined that the taxpayer was entitled to a deduction under s 8-1 of the ITAA 1997 for compound interest incurred on funds borrowed, under a line of credit facility, to acquire an income producing asset. As seems to be standard practice, the ATO ID 2006/298 noted that “While the general anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936 was not considered applicable in this case, the application of Part IVA depends on a detailed analysis of the facts of each case. The Commissioner considers that a scheme in relation to a loan facility would need to have the same features as those set out in Paragraphs 16 – 19 in TR 98/22 before part IVA could be applied.”
TR98/22 reflects the ATO’s interpretation of the outcome of “Hart’s Test case” This case considered the deductibility of compound interest on an investment loan where a borrower entered into a loan which was split into 2 accounts (private and investment) and which allowed a borrower to capitalise interest on his investment account provided he made a payment equivalent to the amount capitalised, to his private home loan account. The High Court ultimately determined that the Wealth Optimiser loan product was a “contrivance” and it is the writer’s view that this decision was primarily driven by the fact that while interest on the investment account was able to be capitalised (normally affording a cash flow benefit to the borrower) the reality was, that if the borrower chose to capitalise interest on the investment account he was required to make a repayment equivalent to the amount capitalised to his private home loan account (no cash flow benefit was afforded him).
ATO ID 2006/298 was the first indication since Hart’s Case on how the ATO would determine the deductibility of capitalised interest on a line of credit facility. Albeit, that ATO ID 2006/298 was not binding on the ATO, there was editorial in the finance sections of national newspapers about its publication and how it appeared that the ATO had at last provided some clarity to taxpayers on the deductibility of capitalised interest on a line of credit facility.
The ATO’s response to this editorial was to withdraw the ATO ID on the basis that “the facts and reasons for the decision” were “considered to be incomplete”. The ATO advised that it would be giving priority to providing taxpayers with clarity on the “deductibility of capitalised interest” issue.
Latest Position
While it has taken some time, we understand that the ATO is now well advanced in working through existing case law to formulate an ATO view for a Tax Determination on the deductibility of capitalised or compound interest under ITAA 1997, s 8-1. This process involves the drafting of the Tax Determination which is then generally submitted to a Tax Council Network or Income Tax Panel for review, before a formal Tax Determination can be published. The TD is usually made up of 2 parts:
1. Binding Determination
2. Non- Binding - includes examples, case studies and explanations.
While the Tax Determination will address deductibility under s.8-1, our understanding is that taxpayers will still be required to seek a Private Ruling if there remains a concern that Part IVA may apply to a taxpayer’s particular circumstances. The ATO has previously approached the General Anti-Avoidance Rules Panel (GARP - this panel is made up or both internal ATO staff and external tax experts) to obtain some general guidance on the application of Part IVA to different capitalising loan structures.
The ATO has advised us that the Review Panel would not provide any general advice on whether the loan structures were caught by Part IVA or not, stating that as the general anti-avoidance provisions of Part IVA applied to individual circumstances, it was not appropriate to issue a general advice to the public. The only guidance the Review Panel provided was that individuals should be able to demonstrate that any arrangement entered into did not have tax avoidance as its dominant purpose. If a taxpayer requires binding advice from the ATO then the appropriate process is an application for a Private Ruling.
We understand that a number of accountants and taxpayers have submitted Private Ruling applications to the ATO. We will keep you informed with updates on the Tax Determination process as well as the outcomes of any Private Ruling applications of which we are made aware.
If you would like any guidance on the Private Ruling Application process please do not hesitate to call us on (02) 92991833 or click on 'Enquire Now' button.
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