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Possible to lend to individual and treat as investment for taxation? what is the structure?

Discussion in 'Accounting & Tax' started by thydzik, 15th May, 2016.

  1. thydzik

    thydzik Well-Known Member

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    Hypothetical situation:
    is it possible for an individual A to loan money to a second individual B with interest, and individual A able to treat this as an investment for taxation purposes?

    My understanding is that if a simple legal loan document is created, the interest earned by individual A is not taxable income and not considered an investment?
     
  2. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Yes it is possible. I set these up for clients all the time.

    Any interest recieved would be income.
     
  3. sanj

    sanj Well-Known Member

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    It won't be considered an investment but the interest earnt by A can and should be considered income. depending on use of funds, B may or may not be able to claim the interest paid as a deduction.

    it's a clear case of being income earnt, similar to say having cash in fixed term deposit and imo definitely not an investment and so should be treated accordingly tax wise.

    simple loan agreement is fine from tax POV, something a bit more detailed/robust is sometimes used to protect A's interest (and recommended in most instances) but that's more of a commercial decision and won't affect tax treatment.
     
  4. thydzik

    thydzik Well-Known Member

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    thanks for the replies.

    lets say there is a cost of the funds to individual A, can this be expensed?

    and what if there is a cost greater then the interest received from B?
     
  5. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    It depends. If you are borrowing to onlend then you may be able to claim your costs against the income received - if there is a commercial arms length arrangement.
     
  6. thydzik

    thydzik Well-Known Member

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    is there any special structure required, or only a simple legal loan document?
     
  7. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    a written loan agreement should be entered between the parties.
     
  8. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    Its almost always going to represent income for A unless its a gift for love and affection. Allowing for interest etc and regular "payments"appears to indicate a loan. However the ATO could also just treat each payment as income (nasty). Thats a risk with undocumented loans.

    The intention to lend and earn interest triggers the interest to be income even with a poorly documented or undocumented loan. Common law principles of "what is income" would apply. The key problem with poorly documented loans is that the interest recipient would be subject to tax and the borrower may not receive a deduction. There is no requirement for the ATO to treat both taxpayers uniformly.
     
  9. thydzik

    thydzik Well-Known Member

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    thanks again for the replies.

    would there be any issues setting it up as delayed once off interest payment on the next financial year, but claiming the costs to lend as an expense the current financial year?
     
  10. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Yes many issues
     
  11. wogitalia

    wogitalia Well-Known Member

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    There could be ways to achieve this but you'd absolutely want to be seeing probably a tax lawyer as well as accountant to ensure it's iron clad because you're absolutely skirting the edges of the law.

    I think having the interest/repayment a one off in a separate year is going to be hard to argue a commercial reason for having done it other than tax avoidance which would trigger the anti avoidance provisions which are almost always nasty when they come out to play.

    But theoretically it could be possible to achieve a result similar to that, realistically prepaying the interest on your borrowings is legal and possible (and often done on rental properties), in your scenario it's timing the repayment that is an obvious issue.

    As always, if you're thinking of doing this I'd be seeing an accountant straight away and if they don't at least think about the idea of involving a lawyer you probably should ask a 2nd accountant's opinion.
     
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  12. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    Asking such a question could indicate a Part IVA concern. (ie hallmarks of a scheme). Its different with a mainstream lender and a prepaid interest facility as its arms length and offered to the world at large. Sometimes these arrangements can be artificially induced too and are legit. A good example includes breaking a fixed rate loan on 20th June and then pre-paying a year interest in June.

    If A lends to B and B then lends to A there is likely to be a non-recourse loan facility. Typical hallmark of many schemes over the years where the tax benefit is really a timing issue due between cashflows (forestry, film etc etc) . The ATO dislikes NRLs where a round robin occurs and tends to deny deductions and apply penalties.

    And promoter penalties could apply where a tax adviser peddles it to clients.
     
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  13. thydzik

    thydzik Well-Known Member

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    thanks again for all the input.

    some important points to consider.

    I shall speak to the relevant people.