Deductibility of interest on interest accrued

I think you will find that whilst this is currently accepted by the ATO it is still in the High Court atm.

I think the issue is the capitalising of interest.

Some folks allow an IP loan to capitalise while they use two sets of repayments to pay out the PPOR (non-deductible debt). This is called split loans and is under legal action.

Sorry I cannot be more definate but it is a dicey area and not a course I would embark upon without some professional advice.

Cheers,

Simon Macks
Mortgage Broker
[email protected]
0425 228 985

Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.

You are probably right Mel. I haven’t been following it closely.

Either way it is something I advise against.

Cheers,

Simon Macks
Mortgage Broker
[email protected]
0425 228 985

Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.

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Cheers,

Simon Macks
Mortgage Broker
[email protected]
0425 228 985

Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.

Kate A
The following is an extract from an article I wrote on the subject.
The score card so far:
1998 – ATO issues ruling TR98/22 claiming that the only purpose for capitalising the interest was to reduce the debt on the private residence so the interest on the capitalised interest was a cost of the private mortgage not the rental property mortgage therefore not deductible. This is a subjective interpretation.
2001 – Single member of the Federal Court, Gyles, J. decided “… the arrangement was to take advantage of the tax benefits (i.e. the deductibility of all the interest). It therefore followed that Part IVA applied to the scheme”.
2002 – Full bench of the Federal Court decided in Hart & Anor V FC of T 29th July 2002 that “the dominant purpose of the scheme was the obtaining of funds, so the scheme was directed to a commercial end – the borrowing of money for use in financing and refinancing the two properties. Accordingly, Part IVA did not apply”.
Appealed by the ATO to the High Court yet to be decided.
It is probably inappropriate for us to offer our opinion on this case as we are accountants not lawyers but nevertheless we are encouraged as the findings of the court in this case could not have been more favourable.
Of course our rental property handout (booklet) has been updated with the findings of Harts case but stay tuned as the ATO has appealed so we cannot recommend relying on this just yet.
In the mean time, it may not be worth the cost of entering into the above loan facilities unless there is a cheaper interest rate offered. Note: If so, this will further support your deduction as the dominant purpose was not the tax benefit but a cheaper interest rate. But if you are arranging finance it may be worth considering one of these loan arrangements as you have nothing to lose. If the appeal turns in your favour, you have already made considerable mileage with your capitalised interest. If it works against you the capitalised interest is not deductible but it has not cost you anything extra to enter into an arrangement that gave you an each way bet. If you are already in one of these arrangements there is no need to bail out yet but consider holding off claiming the interest on the capitalised interest until the issue has finished its full run of the courts.
Note it is not necessary to pay a finance broker to put you into one of these loans, they can be arranged by Don Sutherland through our office with no extra costs than the normal bank establishment fees.
In the 2001 case where the taxpayer lost, the Judge still said that the capitalised interest bore the same characteristics as the simple interest and was therefore deductible but decided that the whole arrangement was a scheme to reduce tax and so caught by Part IVA. This point is worth considering if you are arranging finance, you would have a better chance of not being caught by Part IVA if you do not use one of the loans package for that purpose. For example you could organise two different loans with two different banks. One would have to accept only second mortgage status on your home loan but if you have enough equity it should work. One of the banks loan you more than you need to borrow for the rental property and you use this up by capitalising the interest. Occasionally you may need to refinance the loan to shift more of your equity from the first mortgagee to the second mortgagee. This is just an idea not a guarantee it will work if challenged in the courts it is still wait and see on this topic.

In Harts V Commissioner of Taxation 2001 FCA 1547. The court found that it was an arrangement that the taxpayer would not have entered into if it was not for the tax advantage, so is caught by Part IVA. Interestingly, the court did not agree with the ATO’s argument that capitalized interest is not deductible. The concept is worth considering. It is not for the Commissioner to tell you how to organise your affairs but if you enter into a scheme with the dominant purpose of a tax benefit then he can disallow the advantage sort. If you have two separate loans with two separate banks and one is an overdraft facility for the rental property there is no law requiring you to use the rental money to pay off the overdraft. But you should not have entered into the facility with the dominant purpose of a tax benefit. The loan can be interest only and be drawn on for repairs etc. Similarly, if your business as a sole trader operates on an overdraft you are not compelled to use the business income to reduce the overdraft. It can pay off your own home loan instead. Note none of the above should be read as a way to ensure a deduction. This is simply a discussion of the issues. In fact CCH are of the opinion Part IVA is wide enough for the ATO to consider using it against arrangements like the above. But there must be a line where they can’t call it on arrangement but just normal business transactions. In other words be discrete. The law is unsettled, no one can advise with certainty until the matter goes before the courts.

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Hi Julia,

1998 – ATO issues ruling TR98/22 claiming that the only purpose for capitalising the interest was to reduce the debt on the private residence so the interest on the capitalised interest was a cost of the private mortgage not the rental property mortgage therefore not deductible. This is a subjective interpretation.

Just looking at notes, the TR98/22 Income Tax – (the taxation consequences for tax payers entering into certain linked or split loan facilities.)

Isnt that still going under some sort of ruling still with the High Court? or has that been ruled now?

sorry just a bit confused now.

Cheers,
sis

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