Tax Tip 47: Spousal Loans as a Tax Strategy

Spousal Loans as a Tax Strategy

In the legal section I have mentioned ‘spousal loans’ briefly a few times. e.g. Legal Tip 38 Spousal and Related Party Loanshttps://propertychat.com.au/community/threads/legal-tip-38-spousal-and-related-party-loans.1872/

Now I want to point out some tax benefits of lending your spouse money or borrowing money from your spouse.

The deductibility of interest depends largely on what the borrowed funds are used for. If B borrows $100,000 to buy an investment property the interest on that $100,000 is generally deductible (s8-1 ITAA97).

The same tax laws apply no matter who the lender is. So spouse B could lend to spouse C even though they are married. Spouse C could potentially claim the interest on this loan if the borrowed funds were used for business or investment purposes.

Why bother you may ask? Well, what if Spouse B was a stay at home parent with no income and Spouse C was a public servant earning $200,000. Spouse B would be paying 0% tax and Souse C would paying 47% tax and each additional dollar earn. Spouse B will also be wasting their tax free threshold.

If spouse B lent $100,000 to spouse C to buy a property and if she charged him 10% interest then the income to spouse B would be $10,000. spouse B has no other income so her income for the year would be $10,000.

If spouse C borrowed $100,000 and paid $10,000 in interest this would be a deduction to him assuming he uses it to invest. That means his taxable income would reduce by $10,000 and he saves 47% of this or $4,700.

So the family is $4,700 better off per year.

How does the ATO feel about this? I don’t imagine they are excited, but they have allowed it for at least one person:

PBR Authorisation Number: 1011723892356
https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/1011723892356.htm

However, see PBR Authorisation Number: 1012781169944
https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/1012781169944.htm

A related party loan was deemed not to be deductible because of uncommercial terms.

The loan needs to be properly documented, on commercial terms, and the funds need to belong to the lender. i.e. C shouldn't be gifting to B so that B could lend back to C.

This could work well where properties are owned in single names and a property with a capital gain is sold. It could potentially speed up wealth creation.

As usual this is a complex area and you will need both legal and taxation advice and ideally a PBR.

 

Is the situation the same if the property has already been purchased? ie. Spouse A owns property with loan of $100k. Spouse A borrows 50k off spouse B to put into that loan. Is the interest still deductable or does it have to be set up from the beginning of the purchase?

 

Spouse B could lend money to A at any time. Whether it is deductible will depend on the circumstances, but if properly documented, commercial agreement then it should be treated like borrowing from a bank.

 

And the motivation for the arrangements needs to NOT satisfy the two general tests in Part IVA. Part IVA is a broad anti-avoidance provision. It may apply if a taxpayer satisfies two general tests:

1. Was there a scheme ? (ie steps taken, series, plan etc)
2. Was a tax benefit obtained that was not otherwise available ?.. ie a increased deduction etc

So if the dominant purpose behind a spouse finance is to access a new / increased / enhanced tax benefit then it may fall foul. This is a complex area and of course personal advice would be needed.

Lets look at simple example to assist with identifying a POSSIBLE Part IVA concern with a spouse loan. Helen and Harry are spouses. Helen has a very high income. Harry has a low income. They each own one IP. They consider a clever arrangement to allow Helen to refinance her bank loan on her IP. Harry proposes to lend money to Helen. The current bank loan is P&I and the proposed new loan will be IO. Harry will receive interest from Helen and pay tax on it.

Could this be a Part IVA scheme ? Yes.
1. The scheme appears to provide for Helen to use savings derived from her earnings to gift to Harry which is then lent to Helen. There is most definitely a refinance on the IP however the issue is that of the scheme. No issue with that however we must consider the whole plan.
2. There is a tax benefit. Harry has low income and pays a low marginal rate of tax on interest income. Helen has a high marginal rate and claims a deduction for the interest. The character of the IO basis may also be a concern as a further element to the scheme to obtain a tax benefit over and above that the bank provides. It also may not be. The ATO could express concern that a loan is being maintained on non-arms length terms v's the original loan. The further scheme element could also feature Harry reducing his IP loan.

So when thinking through clever finance etc plans you should ask yourself - Am I doing this to get a tax benefit ?? If so. get advice.

 

I should have linked my tax tip on this topic
Tax Tip 47: Spousal Loans as a Tax Strategy https://propertychat.com.au/community/threads/tax-tip-47-spousal-loans-as-a-tax-strategy.4452/

Where I emphasis that
As usual this is a complex area and you will need both legal and taxation advice and ideally a PBR.

 

I wish i had done something along these lines way back when. My wife and i purchased vacant land in 2006 with intent to build a rental property at some point. The investment loan was in both our names but hers was the only name on the title. This was because she had zero income therefore CGT would be minimal. In reality i was the sole servicer of holding costs.

5 years later the land was worth less than the purchase price. We accumulated $100K in holding costs. We chose to build a rental, but first the land was transferred into my name as the end property would be negatively geared. This was a CGT event. Even now the market value of the house would only payout the finance. I would incur CGT upon sale and my wife's capital loss sits there unused. Had we kept the property in her name and established a commercial loan between us it may have well worked out better.

 

. The benefits of hindsight.

 

Just stumbled on this tip. Having trouble understanding the benefit because
a) Couldn't C just get a loan from the bank for the same net effect?
b) How does B service the 100k loan with no income? Or is this assuming B has stored up spme cash to lend out?

 

a) yes, but.....
b) B would be using cash.

 

It can be a argument raised by the ATO if they think the related part loan is a Part IVA issue.

 

If spouse C borrowed from a bank the interest rate would be around 5% if it is a secured loan. This still would not benefit the family as much because such a loan has not diverted funds from C to B. B's income would still be nil and C's income would be $5k higher.

 

C's income would only be increase if on-lending to B, which would be odd indeed.

 

That's your answer to everything

 

I just had a client today who had inherited some money. I suggested he keep in separate from the spouse and then lend it to the spouse to buy a property. Estate planning and tax considerations where the reasons.

 

When a taxpayer gets sound tax advice and the predominate purpose is NOT a tax benefit then it makes sense. I have seen financial advice that recommended the spouse loan strategy as one taxpayer had far excessive super and there was a compelling reason to boost the personal wealth of the spouse to cater for the imbalance. The wealthier spouse also had asset protection concerns and wanted to diversify asset ownership.

 

What if spouse A lends spouse B money to purchase an IP which will be in both spouse A and spouse B name?

I'm guessing spousal loans won't work for the above situation then?

 

You can't lend to yourself, but you can potentially lend to yourself and another.

 

Just a question, if I have a PPOR loan, and split and recycle accordingly to then lend to my spouse to purchase an IP in their name only, is this possible and deductible still? What evidence is required for this type of thing? I assume this would require ongoing payments from the spouse as well for records at tax time? Thanks in advance!

 

is this possible and deductible still?
yes if correctly documented and maintained. Legal advice is required.

What evidence is required for this type of thing?
A loan agreement, and a loan advance used by the borrower to settle the acquisition and......

I assume this would require ongoing payments from the spouse as well for records at tax time?
Of course. As a loan it need to be arms length and accounted for so borrower and lender agree on the balance due. Otherwise its just a movement of money.

And you will have interest income. But a offsetting interest cost if you borrowed the money.

 

we do these all the time and have applied for private rulings from the ATO. You will require a written loan agreement on terms that 2 strangers would enter into.
The borrower should also be making repayments as per the loan agreement terms also