Pay IP outgoings using a loan

Appears my request for ATO guidance on this issue has been answered by the Christmas elves and the ATO have finally agreed to issue some guidance in writing. I'm told its in the mail (soon?) and have been verbally given some details of the general view. I hope to publish some excepts when it arrives but here is my take at this time -( I was asked NOT to publish the letter on PC so I will need to check what extracts I can publish!!)

The general view is that property investor taxpayers should not utilise any arrangement to capitalise a loan to pay property expenses as this may sometimes constitute a scheme arrangement. The Commissioner has previously issued guidance with respect to general loan arrangements and interest expenses. These views are similar for other property outgoings paid using borrowed funds.

Some instances may be acceptable to the Commissioner where a specific cost is unexpected, compelled, urgent or capital intensive (ie property structural damage) or the taxpayer suffers a short term unexpected situation which affects their cashflow (eg maternity, loss of job) or where the taxpayer seeks the loan for a limited period and it is then repaid to address temporary cashflow issues.

The Commissioner seems to have concern that loan capitalisation to reduce property cash outflows so that the taxpayers enjoy enhanced non-property cashflow over a period of time may be an indicator of a scheme concern where the taxpayer applies less earned rental and salary income cashflow to property expenses so that deductible debt is maintained on those properties while applying increased cashflow to service and repay non-deductible debt. This may constitute a scheme arrangement to which Part IVA applies where the taxpayers change the original loans to enjoy a new cashflow benefit. Such instances may need to be reviewed over a period of time as indication of taxpayer intent and the Commissioner may make assumptions about the future operation of the loan/s. An indication of a scheme may arise in the future where a continued/progressive process is evident. The ATO seemed to identify that later refinance so that cashflow is changed can be a concern but a change in cashflow does not alone indicate a scheme. The indicator of a scheme would be more likely where the cashflow benefit repays the taxpayer or an associate non-deductible debt faster but not if the cashflow benefit enables a further deductible property to be acquired. They accept that this would be a mere rearrangement of financial affairs if loan servicing issues where factors

The Commissioner appears to have no concern with taxpayers who acquire property using maximum loans where that facility is arms length. However, as above I gather that refinancing and altering loan terms to engineer enhanced cashflow changes that produce a tax benefit may produce a concern in future periods. I had asked for an opinion on this cashflow effect and its impact where an offset account is used and was told the final letter explains the position but I was not given guidance on its content at this time as that aspect required further approval. That view would likely be a separate communication but take longer.

Arrangements where spouses or related parties enter into non-arms length term or non-arms length settled loans which are intended to inflate interest deductions for one taxpayer and allow another to derive income which has the effect of providing a tax benefit that benefits the taxpayer or others at any time may be considered a scheme arrangement and the Commissioner would consider the circumstances giving rise to the loan and the manner in which the parties have all entered into the arrangement. This may include review of the nature of the source of funds that the taxpayer lends to the property owning taxpayer (round robins of proceeds as a certain concern) and all the taxpayer intentions as well as arms length loan concern relating to the loan being given, settled and maintained. Where one taxpayer has no right of recourse against the other the Commissioner may cancel the tax benefit under Part IVA.

The Commissioner will later address the issue of using a credit card to pay for outgoings and then the taxpayer charecterising this as a refinance to use borrowed money so that an enduring interest deduction occurs. I wasnt given adequate explanation and my gutfeel is this opinion may be adverse. Its possible from vague response that this demonstrates a reimbursement rather than a refinance and more complex issues arise for the type of loan being drawn down. (ie LOC may be problematic as may an interest free period card ? I did ask.).

Note all the above are the best description I can give using my words based on notes. The final view would likely be different !

 

So in short, don't pay IP expenses with borrowed money unless you really don't have the cash?

 

We will have to wait and see what the ruling says - both the questions and the answers.
Then consider that this ruling only applies to the taxpayer that made the application - but it may be a good guide to the ATO's current thinking.