Tax Tip 46: Want to Pay IO on a PI loan?

But it does capitalise interest v's a P&I position. Sure the indebtedness does not change - It remains constant. But compared to P&I where debt would fall there is a capitalisation. The scheme ultimately does provide a tax benefit. The key question is whether its a predominant purpose. I believe the taxpayer conduct would need close scrutiny.

If a taxpayer did this due to short term period of low income eg maternity AND there is no preferential allocation of cashflow saving to PPOR or other non-deductible debt as a consequence it MAY .....not be a Part IVA concern. But I would think the public interest test would mean no ruling is given that says "Part IVA will not apply"....I reckon it would say the Commissioner may consider Part IVA could apply if the scheme provides a debt reduction etc through taxpayer use of the cashflow savings. ie a failry useless ruling IMO.

Its like the response I received to one about tax offsets... I asked if the Commr would consider use of a scheme to use a interest offset a Part IVA issue in some examples. Answer was verbal (!!) froma high level ATOer so it must have aroused curiosity to escalate it...Possibly and why the Commr wouldnt issue a ruling. A BPR often wont be issued about a matter of general tax law ie Part IVA.

 

Based on todays rate - would this work? If there is commercial benefit for the customers, then the ATO may see this more positively... if it is purely to reduce tax, even at a higher cost before tax, then this could become an issue with the ATO.

For example, July 2017 rates (say, St George):
Investor - IO = 5.07%
Investor - PI = 3.99% fixed for 5 years.
LOC = ??

 

It certainly would be in the taxpayers favour. Good thinking.

 

Agreed - I think this strategy has legs... its not to reduce tax or increase deductible expenses - purely for the taxpayer to reduce interest cost (from 5.07% down to 3.99%) by way of a go around so that the bank will provide the lower rate.

 

That argument doesnt remove the view the ATO could form about predominant purpose....being a tax benefit. The exchange of a interest rate doesnt truly wash. You are exchanging debt reduction for maintaining the debt as a scheme element. The maintenance of the debt at a slightly lower or higher rate or even the same rate is not a material issue. In the P&I situation the interest cost for the principal element repaid is $0. In the IO exchange under the scheme its $x based on whatever the rate is.

The ATO often attacks schemes based on round robin / limit recourse funding etc and they look at the constructive matters surrounding comparing two subjective positions. In this instance you are comparing debt reduction with debt maintenance. The rate you exchange it for is capitalised whether its 3% or 6%

And I dont believe "the bank" is lending to support the scheme. Lenders would avoid it like the pox. A scheme element that the taxpayer creates using a LOC etc

 

what if the "Principle" amount in the PI isn't used to reduce non deductible debt (ie PPOR payments). The money saved or used a disposable income.

Therefore tax isn't reduced, infact as expenses (interest payment) on investment property is reduced (from 5.07% to 3.99% using todays real rates) then wouldnt this be viewed different by the ATO?

 

Concerns about capitalising interest arises from capitalising and creating a tax benefit. Not the interest rate at which it occurs.

 

With this the total owed would remain the same.

 

My ANZ broker is saying that he cannot set up a direct debit for a fixed P&I loan payment from another financial institution, despite previously advising this was possible (before I fixed and changed to P&I).

Question 1: Has anyone managed to set up a direct debit "pull" for a fixed P&I ANZ loan from an OFI account before?

Broker, without knowing the entire story, says "just push the payment into another ANZ account and ANZ will debit it from there". But this, even if the "parking account" starts at 0 every month (no mixing) would break the directness of the refinance. The situation would be similar to "Parking borrowed money in an offset account". On the other hand, due to recently having deferred my monthly repayment date by 2 weeks, I'm in a fortunate situation where I know the exact interest amount for the month 10 days ahead of the P&I payment date. This now allows me to know the exact split of interest and principal portions of each payment ahead of time, and would allow doing this:

1) On 10th day of the month I find out that interest for the month is e.g. $1992.
2) This means the principal amount (to be refinanced) is my fixed payment ($3200) minus $1992 = $1208.
3) On 21st day I transfer $1208 principal from an OFI LOC into the ANZ "parking account".
4) On 21st day I transfer $1992 interest portion from elsewhere into the parking account.
5) On 24th day ANZ automatically debits a loan payment of $3200 from parking account.

Question 2: Does crediting the interest payment into the intermediate parking account (on top of the "ready to refinance" principal) cause any mixing issues? I believe it doesn't. It's a similar investment funds consolidation situation to a buyer drawing equity to fund deposit of a new purchase, having the drawdown proceeds parked in a clean offset account and then topping the account up with some extra cash to arrive at the full 10% deposit amount to be paid with a single cheque.

Question 3: Wouldn't this arrangement be actually preferable/cleaner, as there is no capitalisation of interest at all in the LOC - not even for the short term of 1 or 2 days that the standard approach outlined in this thread would require?

 

Also, to everyone who says this is a scheme to provide a tax benefit, I believe you're looking at the issue from the point of view of "there was principal reduction in a P&I before, now there isn't, which means people pay and therefore tax-deduct more interest, so this must be a scheme with a tax benefit".
1) If this was the case, what about all the people who changed their repayment type with the bank from oldschool P&I to IO over the last 10 years, is the ATO pursuing them for engaging in a scheme because their tax deductions are higher due to paying higher interest on a non-decreasing loan principal?
2) If I employed this strategy, I would be going from an IO-loan. Without the strategy (null hypothesis) the principal would not be reducing either and interest (even higher due to higher bank rate for IO) would still be deductible.
Hope these angles help with the discussion.

 

Is it possible to just initiate an LOC transfer yourself directly into the loan account and completely bypass the offset? And similarly transfer the interest portion from the offset into the loan account?

 

Yes that would be possible (but perhaps per my Question 3, a separate parking account might actually be preferable?). However, there are two potential issues:

1) Would ANZ allow a loan to have no associated direct debit for automatic payment? My hunch is probably not, they always wanted me to nominate one.

2) Timing. Do it too early and it's considered an extra repayment (triggers a fee on a fixed loan). Do it too late and you're in default. I believe the system is too much of a "black box" to be able to consistently get the payments properly "understood" by the ANZ IT system (I've been experiencing ongoing crazy glitches with them - IO loans getting reductions of principal, transactions not appearing on the receiving account transaction ledger despite being processed etc. - and have no trust in the system whatsoever).
2.1) Splitting into two payments could make the whole process even less predictable as all of 2) still applies

 

Since IO loans are still around, then you should simply keep records showing what was available and you should be able to use that to demonstrate that the purpose of your "scheme" was to reduce interest payable (which actually increases tax payable). I would get a PBR first to confirm this, though.

I haven't dealt with ANZ, but all other banks I have dealt with will allow this. They prefer you to have automatic payments and give you the paperwork as if it is a requirement, but if you push them and say you want to manage payments yourself then I have never been rejected. It's useful for fixed loans where you are transferring the money from a lower rate variable loan, I transferred the money on the first day of the month rather than wait for the auto payment on the last day (I also made a larger payment but not enough to trigger any interest penalties).

The problem is accurately calculating the interest ahead of time, as usually it is debited from the account at the end of the day when the payment is due, so you can't see what has to be paid until it is too late. I use spreadsheets to calculate interest payable, but every so often I stuff up a payment date in the spreadsheet causing an error in the interest calculation. You could overpay your interest by a few dollars every month just to be on the safe side, but it would still be a very manual process (each interest payment will be different, and so need to be manually transferred each month)

I have a friend who was trying to set his loan up with automatic payments with the interest from one account and the remainder from another. The bank had no facility to allow this.

 

Update: Q1 answer (direct pull by ANZ from OFI) is - not possible. However they allow to have the loan set up without a nominated direct debit. I.e. it is possible, on the loan payment due date every month, to 1) manually transfer interest portion directly into the loan from a savings (non-capitalising) account A, and 2) manually transfer/refinance principal portion from OFI LOC account B.
For example, an early morning payment from WBC reaches ANZ in late afternoon.

 

A lender cannot mandate a method of loan payment. They can put up blockers but cant refuse. Many lenders falsely give the impression a loan MUST be paid by Direct Debit. A lender insisting funds come from their own savings accounts seems like third line forcing and could be anti-competitive.

The loan has a BSB and account number and any account holder can cancel a DD authority at any time and provided allowance is given for delays in transfers (of up to 24hrs) from another bank by EFT then it can be done. The account holder can also setup a direct credit authority with the other bank to ETF automatically to the lender bank loan account.

The new payments platform allows real time transfers if your bank wants you to use it. I have noticed they have all gone quiet on this system cause they all lose out on holding money for a day. Say 4 billion in transfers and Bpay between other banks x 2% x 1 day = $219million if I have my maths right....No wonder they have a bank holiday - They can make $657 million by not working.

 

This is a very interesting thread but I could not follow all of what was said so hopefully im not asking the same question. My interest only loan rates have gone up I had a similar idea to what was discussed here. What are your thoughts on the these two scenarios?

1. My Interest only loan (480k) for my investment property gets converted to P&I for the purpose of getting a much lower rate, but I really dont want to pay anything off the principle, so I make a loan split for 1 years worth of payments from my PPOR, pay that split off completely from the offset and then use that loan to pay the the investment loan (P&I). This would be capitalising the interest, but the main purpose is not to pay less tax, its to maintain my ability to access money from my loans, this is important because depending on if I change jobs, the royal commission outcomes, I would not be able to borrow to the same level (e.g even if I put 50k more equity in the investment property through paying the principle, I will not be able to borrow that 50k back because lending requirements/borrowing power). Do you think this is reasonable? I think this should be allowed, but I think it comes down to interpretation and I think I know what the guru's will say.

2. As above except that I tell AMP that I will be paying the P&I investment loan repayments manually and have to setup transfers for the interest from the PPOR offset, and the principle from my loan spit. Unlike the above, this will not be capitalising interest, just principle. Im annoyed at having to go to these lengths, I dont like the idea of manual payments that need to be adjusted every time the rate changes.

If the ATO takes you to court over these issues and you win, will they cover your costs? or you end up out of pocket no matter the outcome?

 

1. The "loan split" isnt deductible so the new loan/s comprise two elements - Deductible $480K and non-deductible $XXX

2. Isnt the interest on the split non-deductible?. Using the non-deductible loan split to repay the $480K loan still reduces the debt since it has a P&I requirement. The bank requires that. How do deductions change for the $480K ? Doesnt the loan reduce because of the P&I requirement.

3. Seems like a tax scheme and (IF) you obtain a tax benefit, if one occurs. Is that the predominant purpose for doing this ?

The tax benefit is that had the loan not been split your repayments would have reduced the loan principle be applied in a proportionate manner to the whole loan so that the deductible portion reduces in same ratio as the non-deductible. I still reckon there is no tax benefit. All you have done is create a debt to pay off your loan but its not a refinance and doesnt make the split deductible. Its like living on a credit card.

If there is a benefit Part IVA must be considered. A binding private tax ruling may assist avoid the benefit being treated under avoidance laws one day in the future.

LOL - The ATO doesnt pay costs. They have deep pockets. You pay your own costs to object, appeal and so on. It would be cheaper to seek advice first. I have once seen a taxpayer awarded 100% of costs and its very rare. And what they got was under 50% of their costs after the costs were assessed. So even a taxpayer who wins is generally seeking to avoid the primary tax, penalties, interest and a liitle of their costs at best

IMO you may not get a favourable ruling.

 

Hi Paul,
I dont think I was clear enough. Currently lets say I have 480k investment IO loan, 290k PPOR IO loan with 50k in offset.
This becomes 480k investment P&I, 240k PPOR P&I, $0 IO loan (with 50k redraw). As the loan repayments for the 480k investment come out of the $0 split, it becomes tax deductible. Rent goes into the offset, PPOR repayments come from the offset and interest payments on $0(50k) interest only split come from the offset.

scenario 1. is about taking the 480k loan principle and interest payments from the split

scenario 2. is about taking only the 480k loan principle payments from the split (in terry's example it was a LOC), and the interest payments coming from the offset.

And instead of paying 3.99% on 480k im only paying it on whatever is redrawn from the split.

 

1. Split is non-deductible. It doesnt relate to acquisition of the property and in the absence of a tax ruling the ATO consider capitalised interest a concern
2. Interest is accrued based on debt. It is whats deductible. Not whats paid. You can pay same as what is charged (IO) or more (P&I) but bank will have issues if its less.
3. Yes rent to the offset (which reduces PPOR interest).
4. Doesnt matter where repayments to IP loan come from. If you borrow those repayments refer to #1 above.

Incorrect. See #1 above

 

Paul your a guru, but are you sure? Its the same as refinancing, i'm paying for the investment property (principle payments) with a separate loan (a split) that is only used for paying for the investment property.

Otherwise when refinancing an investment property the interest on the new loan is not tax deductible.