Tax Tip 452: Parental Loan Strategy – Borrowing to invest

Discussion in 'Accounting & Tax' started by Terry_w, 11th Aug, 2022.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    This is a different strategy to a recent one which involved borrowing money from parents and parking in an offset account to save non-deductible interest. See Tax Tip 441: Borrowing Money from Parents to Save Interest Strategy Tax Tip 441: Borrowing Money from Parents to Save Interest Strategy

    Instead of doing that and slowly debt recycling, the borrower could borrow to actually directly invest. The interest rate could be potentially high, as long as it can be justified from a commercial point of view, and this can allow for greater savings overall between both parties.


    Example

    I had a client who had borrowed $300,000 from his mum as she was not earning much on putting the money away in a term deposit. This money was in his offset account.

    Separately, he also wanted to borrow an extra $300,000 against an investment property to invest into shares.

    I suggested instead why don’t you consider to just borrow the $300,000 off your mum to invest in shares. This would be a risky loan, to mum, as it would be unsecured so she could justifiably charge you a higher interest rate – potentially 8%.

    He could then invest this money into shares and pay his mum $24,000 in interest. Mum might pay 20% tax on this as she is working part time and on a loan income.

    The son would be investing in low yielding shares so they would be fairly negative geared and he would be suffering an income loss. If he pays $24,000 in interest he would ‘save’ almost $12,000 in tax, yet mum would only be paying about $5,000 in tax.

    Between them they would save about $7,000 in tax.

    The son could also borrow an extra $300,000 now but not yet use it. This could be retained as a buffer just in case mum would quickly need her money back. He could then use this loan to repay mum and have the interest deductible still.

    The down side is that had he just borrowed interest free from his mum he would be paying about $7,000 less non-deductible interest on his main residence loan. This would help him debt recycle further.

    Which is better?? The numbers would need to be run and further exploration is needed. Other non-tax issues would also need to be considered as well.


    Legal and tax advice is needed on this as the anti-avoidance provisions need to be considered.

    And note that it is not limited to parents either
     
    craigc likes this.
  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Care should be taken that the parent understands the interest is reported as their taxable income. Offshore parents and loans should be avoided without advice on withholding tax. If the parent or grandparent (for example) have any possibility of pensions in the next 5 years its critical the loan is legally documented to avoid centrelink gifting tests applying. Centrelink will count it as a investment under the assets test if its a properly documented loan.

    Parents and borrowers should also consider what occurs on death of the lender. It can create awkward family dymanics if lender dies and other family (executor etc) demand the loan be discharged. I avoided that issue many years ago when a kind grandparent offerred this type of arrangeent but we had concerns for their lngevity and the need to pay it out abruptly. Literally 2 months later this occurred. We doded that issue.

    A parental loan can also be effcetively used to temporarily borrow until a equity release etc can be approved. Then the bank loan can refinance the parental loan. Important this is legally documneted and isnt just a informality
     
    Terry_w likes this.