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Using borrowed money for multiple investment purposes

Discussion in 'Accounting & Tax' started by Wukong, 10th May, 2016.

  1. Wukong

    Wukong Well-Known Member

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    Let's say we borrowed 100K via a top up property loan of which 50K has been used to purchase an IP.

    If we use the remaining 50K to invest in shares, the interest on the 100K would be deductible?

    Thanks guys
     
  2. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    The use of the funds determines its deductibility. The problem with using one loan for two (or more) different purposes means that tracing the use of the funds can be complex and leave a blended loan.

    The interest on the $100K must be apportioned based on its use and the time advanced which could require some apportioning. The interest must be claimed at different parts of the return when used for mixed purposes.

    A split loan (ie two loans each $50K can assist and simplify)

    On the shares - Its isnt automatically deductible. The shares need to have a expectation of paying income. eg dividends. If you buy shares on a spec basis that dont pays divs the interest may form part of the CGT cost base.
     
  3. chylld

    chylld Well-Known Member

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    Following on from Wukong's scenario, and assuming the shares are income-producing, what happens to the deductability of interest if the shares go down in value and are sold for e.g. $40k?

    TR 2000/2 para 45 states that the shares' $50k borrowing is no longer considered as being for income-producing shares, therefore only the interest on the $50k IP borrowing is deductible.

    However after paying down the LOC with the $40k share sale proceeds, there are $60k borrowings remaining, and any further payments into this LOC will come proportionally off both the $50k IP component (deductible) and the $10k stranded component (non-deductible).

    Does this mean the interest needs to be apportioned forever?

    Is the only way to fix this splitting the LOC into 2x $50k LOCs prior to selling the shares?
     
  4. Rob G

    Rob G Well-Known Member

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    Don't use a LOC.

    The harsh outcome from selling an asset at a loss is because it was financed from a LOC.

    The Commissioner holds that a LOC is refinanced with a new borrowing each month and the purpose changes with each refinance.

    If the shares were financed from a longer term investment loan then the Federal Court will likely be more reasonable. See FC of T v Brown, concerning a business loan repayment shortfall on cessation.
     
    Terry_w likes this.
  5. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Chylid i wrote a legal tip on this question or maybe it was a tax tip.
     
  6. chylld

    chylld Well-Known Member

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    That case refers to the deductability of interest after the sale of the business / income-producing asset. I already assume the interest on $40k is no longer deductible; I am interested in the $10k.

    I remember this being discussed before but I can't remember there being a clear answer to this particular question.

    Selling the shares at a profit allows the full $50k shares borrowing to be paid down with sale proceeds, leaving a clean $50k for the IP. Selling the shares at a loss was much less clear-cut.
     
  7. Rob G

    Rob G Well-Known Member

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    Brown's case involved sale of a business but realising insufficient proceeds to repay the 10 year loan in full.

    The taxpayer was still able to deduct the interest expense on the remaining loan principal. Full Federal Court.
     
  8. chylld

    chylld Well-Known Member

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    I totally misread the end of paragraph 1, you're right. Thanks for the summary.

    So does it follow that the $10k's interest remains deductible after the sale of the shares?
     
  9. Rob G

    Rob G Well-Known Member

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    The Commissioner holds in TR 2000/2 that the interest is not deductible if a LOC is used.

    This is a harsh and literal view that a LOC is refinanced every month and the purpose of the new borrowing rapidly loses it relation to original income earning activity. This still echos the arguments used by the Commissioner in Brown's case.

    However, a case concerning a LOC has not been litigated to my knowledge and so is untested in the courts.

    Perhaps it would be better to split and put the $10k loan on a more permanent footing to be more like Brown's case before too many months (of purported refinances) occur.

    However, if the entire $40k proceeds were instead reinvested rather than being repaid into the LOC then the entire proceeds are still being used to earn assessable income. This is despite the fact that a loss has been realised.