Tax Tip 457: Borrowing to Invest in Low Yielding Shares and Tax

Shares can be negative geared just like property. This can even be the case where you borrow against property to buy the shares – for tax the gearing should be linked for the use rather than the security for the loan.

Interest should be deductible where there is an expectation of income, even if that income is less than the cost of holding the asset. This is because of s8-1 ITAA97. It could be argued that where there is no expectation of turning a profit the interest won’t be deductible though. This could be a situation like borrowing at 5% to invest in a term deposit at 3%. Such a transaction has not commercial purpose as there will never be a profit. But with shares you will be expecting capital growth to happen over time and this will cause the dividends to rise and eventually exceed the cost of owning the shares.

This could mean high growth and low yielding shares could allow for tax savings. The shares can be negative geared early on and slowly over a number of years they will turn cashflow positive and produce taxable income.


Example

Lisa is a high flying income earner, she is a pilot and earns $200,000 p.a.

She borrows against her main residence and invests $1,000,000 into a particular share. Her interest rate is 5% and the shares pay 2% dividend.

She is making $20,000 income but has $50,000 in costs so a loss of $30,000 in the first year.

This will save her $13,300 in tax approx.

The following year the shares may be worth $1.1mil with dividends of $22,000

Slowly over time her dividends will increase and her interest will remain the same (if no more rate rises) or reduce (if paying PI).

Lisa will be making a profit at some point.

 

Is there any difference if the share currently pays a zero dividend, though the company is profitable?

 

Yes, no deductions if no income or expectation of income.

 

The same principle is applicable to the interest incurred on a loan used to aquire Cryptocurrency that generates assessable staking income...

...however using the above logic, I reckon the ATO could have a field day disallowing interest deductions simply based on the argument that they don't think crypto will ever be profitable.

But it doesn't matter though because Matt Damon reassured me that Fortune favours the Brave!

 

There is no test for "profit making". s8-1 merely consider that income is produced so a outgoing can be claimed. It need not be commercial. This is sometimes a feature of a tax scheme to take advantage of that rule eg defer much of the income etc. Mosts scheme work on the bais of altering the timing of the income matching principles and the decision in Steele's decision whilst it relates to property rovides good insight to this matching process. The s81- test is the security interest produces income or is expected to produce income. By income we are referring to paying the shareholder a dividend or distribution of income. A return of capital is not income

I will use some examples.

• Qantas sufferred enormously from COVID and while it may have paid dividends in the past there is no present expectation. Borrowing to Buy QAN would not permit deductions in the past few years or even now.
• VAS suspended its income paying in the final Quarter of 2020 when covid hit. A existing owner would expect this to resume (and it later did) and the suspension is not a indicator of NOT paying income. . A new investor may also reasonably expect future income. Borrowing to buy VAS at that time should be deductible.

Buying shares that presently do not pay income would not be deductible interest until such time income is declared by the company. Therafter the interest may cease being a CGT element and commence being deductible. There is no need to consider the earlier intention of the taxpayer.

There is no test for how much income is paid. It could be 1c per share.

 

Is there any case law where a taxpayer was denied interest deductions under s8-1 for the purchase of a listed share because it didn't pass the expectation of future income test?

 

Interest of borrwings to buy crypto is not deductible where it doesnt produce income. Generally speaking you must do another thing after acquisition of crypto to make it produce income. eg staking etc. A commerciality test of how much income it produces is not required. That said, the ATO can use Part IVA if a taxpayers undertakes what is argued to be a scheme to produce deduction benefits. They can cancel the deduction mhich then makes the interest a capital outgoing.

This occuts too with non-recourse arrangements. If you entered into a scheme to rent crypto for 1 c a day and then its bought back at a predetermined price that locks in the sale price then its a likley governed by Part IVA. You generally must hold securities at risk to claim deductions under thsi view. This has been made into more precise laws for the 45 days holding period rule etc. But that to stop franking credits being stripped or traded

 

Unnecessary to have case law. Its a issue of fact based on statute law. Audit decisions commonly say this. ATO often review interest and dividend deductions. They look at the use of the borrowed funds and what was acquired. Its pretty fundamental stuff. Its where a offset to hold funds before use can become a concern etc. I have seen borrowings by a husband credited to a commsec held by wife too. No agreemnet to onlend ? So wife doesnt incur andy interest. They are wise to mistakes taxpayers make. Thats why they check randoms.

I believe the risk is enhanced by the value of the deduction claimed at either item 13 or D7 or D8. This is why taxpayers claiming $5K or more at D7/8 may need to include a special schedule to indicate who was paid te interest and more. Tax returns also contain a error exception that stops deductions at D7 if interest income isnt shown and D8 if divs arent shown. Reporting $1 of income to bypass this a high risk

 

Are the rewards from crypto staking, which seem to come in the form of more crypto, considered a dividend or a bonus share issue?

From the income thrread:

 

Neither

1. A dividend is a share of profit paid by a company.
2. It CANT be a bonus share as its not a share

The return on staking is value merely given in the form of coin. Its a two step process. The value of the earnings become eleigible and then converted into coin.
This is both income and the costbase of the new coin given.

Its like a DRP is to new shares