Tax Tip 280: Loan Repayment Holidays and Tax Deductibility

For anyone contemplating a repayment holiday on their loan, you must realise that the lenders will still be charging interest, and this will be added to the loan. This will result in interest on interest being paid.

Where the loan relates to an investment property – i.e. it was used to either purchase and/or repair an investment property – the tax aspects need to be considered.


The High Court has said that interest on interest can be deductible where the underlying interest is deductible. But there is a possibility that the Commission of the ATO can apply the anti-avoidance provisions to deny deductions if this was done as a scheme to increase tax deductions.

One example of a scheme may be this:

Example

Homer has a home loan an investment loan. Homer asks the lender for the investment property to give him a repayment holiday. As a result, he stops paying the loan for 6 months. This gives Homer an extra $10k cash which he then uses to reduce the loan on this main residence.


In a situation like this the Commission could deny the extra deductions as this seems like a scheme to increase deductions on the investment loans.

But this doesn’t mean you should not do it – tax advice should be considered.


Would it be different if Homer placed the extra $10k in the offset account against his main residence? I think it would be but get your own tax advice.


If you do not wish to claim the interest on interest you would need to make some manual calculations and work out the amounts. I don’t think accountants would do this for you.

 

Just thought of something. A lot of these repayment holidays may come with capitalised interest which might be added 6 months down the track. This might effect tax deductions and push them over to the following financial year if the interest is not incurred this year.

 

Now with difficulties due to COVID-19, if one has an investment property and opted to defer loan repayments for 6 months, will the interests on capitalised interests be tax deductible?

 

I covered this above.

 

Based on what I read on CBA website, I think during the deferred period, the interests are still charged and added onto the loan the same way as before.

 

If that is the case the normal rules will apply. Interest on interest is deductible unless the ATO finds it is a scheme used to increase deductions.

 

I’ve been thinking about applying for a binding ruling in this space.

Obviously lots of previous examples where this isn’t allowed - I wonder whether the circumstances dictate you might get a different response.

Still debating the effort.

 

Very hard to get a ruling on Part IVA these days

 

I would argue that there is no need to apply for a Part IVA ruling if the repayment deferral is based on the economic situation arising from CV19 and hardship and is specific to the owners and / or tenants. This is consistent with other ATO public rulings.

Utilising CV19 as an excuse to capitalise would likely remain a Part IVA concern otherwise. The Commissioner is very tolerant of hardship circumstances. And more intolerant of people who seek to evade by falsely representing themselves.ATO staff are allowed to be personally offended by peoples actions. And then they get nasty. All perfectly legal of course. Its like swearing at a cop v's a polite approach. One may get you off the ticket and the other wont.

 

Bankwest says (and I assume CBA is the same) that they way it manages these repayment "holidays" is to debit the interest from the loan account each month, and immediately increase the credit limit of the loan by a corresponding amount. Does this not mean that, from a tax perspective, interest is still incurred by the taxpayer each month and he is still 'paying' said interest, but just taking out a small loan each time to do so? Therefore interest costs are still incurred within the month and financial year to which they would ordinarily correspond?

 

Yes

 

After reading the replies I noticed my earlier post could have been interpreted differently.

As an overall my intent was to not do something the ATO could look upon unfavourably. Just trying to be cautious by thinking about a private ruling.

The circumstances I referred to are: working in the travel industry.

 

If I was advising a client in the travel industry I would be discussing cashflow maintennace and the ability to use borrowed money to meet commitments would be part of that. I would not have concerns with a temporary loan capitalising arrangement such as this provide you dont choose to favour only IP costs using borrowed money but a balance of all household commitments. Beware of blending loans of course

There needs to be a scheme element to capitalising for a concern and that can be broad but isnt that rigid either. eg If you needed to pay your own mortgage and the IP on the same day and borrowed only to pay the IP. But if the only credit facility available was the IP one then it may also be quite sound to use that as a defence.

 

If taking out a 'small loan' each time then only the interest on that 'small loan' is deductible and not the loan amount itself?

 

My understanding is (regarding the specific Bankwest / CBA mechanism discussed above): Interest is being incurred on the loan and debited from the loan account monthly. Whether you(the fictional taxpayer) are making payments in to the loan account or not, you are incurring these interest expenses.

How that interest debit is reconciled (either by payments in to the account or by increasing the account credit limit, or some other mechanism) is irrelevant, and the interest is deductible within the tax year that the interest debits occur.

Separate from this is the matter of capitalising interest and the deductibility of the interest on the interest e.g. the "small loans". That is more subjective and dependent on individual financial circumstances as to if that flies in the eyes of the ATO.

 

Interest being charged isnt automatically deductible. Interest deductions can be compromised in many ways. eg a home loan reduction arrangement could be a scheme even if it was implemented by a lender. eg TD 2012/1. Even prepaid interest may not always be deductible at once or 100% : Rent and a further example : Fred prepays interest on 28th June 2020 for 12mths. On 31 July 2020 he stops renting the property. Fred should reduce his 2020 interest deduction claim

For the purposes of COVID arrangements where a taxpayer has a financial impact necessitaing assistance by a lender and holidays / deferrals etc I would not expect the ATO to consider that a concern HOWEVER if the taxpayer was to at that same time contrive and create a scheme to obtain a enhanced tax benefit then the ATO could later have concerns about the % that is deductible.