Warning - Paying Rental Expenses Using a Loan

Some people advocate using a LOC or other sources of borrowed money to pay property expenses other than interest (which may be subject of a more specific view by the ATO).

I came across a ATO communication between the ATO and a tax adviser at Bantacs...Julia Hartmann. Its a couple of years old but I am unaware of any recent rulings or views of the Commissioner that alter this issue.

In this letter from an ATO technical / executive officer and not some junior underlying the apparent question of interest capitalisation of property expenses and the application of Part IVA appears the theme of the questions posed.

Interestingly, the ATO response has two bullet points towards the conclusion.
1. Addresses the situation of using borrowed money due to an unexpected financial situation or unexpected change of circumstance. We see example that often include maternity leave, loss of work etc. The ATO appear to accept that in such cases its more likely that Part IVA would not be invoked to deny such a deduction for INTEREST or other costs.

2. This bullet point is the matter of apparent concern. In this reply the ATO response contemplates NON-INTEREST deductions paid using a line of credit to pay unexpected costs of repair. Again the view taken is that Part IVA may be less likely to apply. The nexus is to the financial position again.. That is the major concern. The inverse position may well apply that where there is no unexpected change in financial position that any costs paid by LOC are a concern as an apparent scheme. Especially where a process of continued capitalisation is made.

This raises a key concern. The ATO appear accepting of the view that Part IVA may well apply to the use of capitalised interest to pay property outgoings in a methodical and consistent manner of any kind where there is not a unexpected substantial change of financial circumstance. In other words, paying any costs where they are methodical and expected using borrowed funds and there is no financial circumstances imposing use of borrowings then there may be a concern.

I share this concern and advocate anyone seeking to capitalise or increase loan balances (and therefore interest) for ANY property expenses on any ongoing basis seek a private ruling. I have reservations it may not be given.

If anyone considers they may be in this position I would be acceptable to offer a test case by assisting your private ruling request (subject to conditions !) at no charge. Contact me directly (not through PC) and we can discuss. This offer may well appeal to someone considering use of such a process v's someone already doing it (which may then be an admission)

 

Thanks for posting @Paul@PFI. I am in the position where I could borrow to pay IP expenses but I have not done this because I don't feel it is justified in my case. My reasoning is this:

1) I don't have non-deductible debt, so I can't argue that I am directing my income towards paying down non-deductible debt as a priority.
2) I have sufficient income to cover all rental expenses and from this point of view I can't see a justification for borrowing to pay them.

It's not something I would be comfortable explaining to the ATO, so I have chosen not to pursue this.

 

It would certainly be interesting to see the ATO's response in a PBR. It could be guidance on the ATO's current approach, but a PBR only applies to the person who applies for it.

So far there is nothing to indicate the ATO will apply Part IVA to deny a deduction and there is a good legal basis to be able to claim interest on money borrowed for investment expenses.

 

All points I agree on. For anyone interested I seek to ask about an arrangement where a taxpayer has the following specific features :

1. Has an existing IP and IP loan (or more than one loan for the acquisition)

2. Taxpayer later applies for a new loan facility (LOC or other credit facility).

3. The new loan facility from a commercial lender is intended to solely or predominantly pay rental outgoings for neg geared IP expenses except loan interest.

4. Taxpayer has no immediate domestic / financial issues with meeting the rental outgoings but chooses to use borrowed funds.

The ruling request would be for a ruling or determination, decision or other public opinion of the Commisssioner in preference to a BPR.

 

Hey @Paul@PFI,
Just tried to message you about this but had a problem. Can you PM me your contact details so I can follow up with you.
Thanks.
Hedgy

 

See Pauls signature for contact details.

 

Did you get someone to be your test dummy?

 

Client...

 

Crash Test Dummy?

 

I have two taxpayers with slightly different issues who would meet the requirements.

I am also considering a scheme that involves a offset facility. I think there is a Part IVA concern that follows with tax offsets used in a particularly common way. The common thread is these matter relate to engineering loans so that a deductible loan is maximised which otherwise may have a lower balance if the scheme features are not evident. I am considering this at present

 

Interesting. I've seen similar threads like this appear before, but like one of the earlier posters. Previously I didn't have any non-deductible debt.

Over the next 6 months, I will have some non-deductible debt, and obviously want to reduce/repay that if I can then focusing on maintaining the payments on my properties.

Essentially whatever is outlayed throughout the year, I get this back through my annual tax return.

I do have two undrawn LOC thats been set up a few years ago.

Am I able to rely on these LOC's to pay for each properties interest/expenses, and direct all income throughout the year to my upcoming non-deductible debt. And on the tax refund each year, chuck that into the LOC to reduce?

 

Yes, but consider Part IVA and the ATO denying the deduction.

See
Tax Tip 4: Borrowing to Pay investment expenses https://propertychat.com.au/community/threads/tax-tip-4-borrowing-to-pay-investment-expenses.1554/

 

I would argue it could be determined by the ATO to be wholly or partly non-deductible but then I dont have a private ruling and neither do you. I would consider your use of LOC a scheme to obtain a tax benefit.

The interest is a specific concern already subject to the Commissioners views.

 

This is very interesting and please keep us updated on the outcome of a private ruling.

I have often thought this practice is similar to using an LOC or the like to capitilise interest on a property purchase which the ATO have deemed as illegal.

 

ATo hasn't determined that capitalising interest is illegal. In fact they have even said it can be deductible - but they can deny the deduction in certain instances.

Did you know that negative gearing is a scheme often done with the dominant purpose of increasing tax deductions. Part IVA could be applied to this too - but the ATO has indicated that it won't.

 

If you had to defend against the ATO applying Part IVA in this situation, what would you rely on?

It doesn't seem particularly onerous for the ATO to prove that the dominant purpose of paying rental outgoings via LOC is to gain a tax benefit, especially when you've got plenty of funds sitting there to pay them out of your own pocket.

After all, what reason is there to borrow to pay outgoings when you have the ability to pay them out of your existing funds except to gain a tax benefit? Anyone have a good excuse?

In saying that, the ATO seems extremely hesitant to apply Part IVA to anything, so it would be a surprise if they did choose to apply it to the scenario Paul has outlined.

I think they like the threat of the stick rather than actually using it.

 

What about paying interest only on an investment loan while PI on an owner occupied - Most would be doing this with the dominant purpose of increasing deductions.

Where do you draw the line?

I did a google tonight and found something else of interest

NTLG consultative workshop on Part IVA amendments
See example 10 down the bottom
NTLG consultative workshop on Part IVA amendments

And see their discussion at:
NTLG consultative workshop on Part IVA amendments

 

Negative gearing is a term used to describe passive investment. The scheme elements dont exist.
The use of a LOC engineered to pay rental costs that are capitalised while the non-deductible loan is reduced has many elements of a scheme

 

Interesting topic Paul. Please keep us posted on private ruling.

I think, in most of the common arrangements ATO has left the door open to apply Part IVA for themselves. I guess when they see its being abused at a level not feasible they'll take couple of cases and prove the dominant purpose and restore the baseline. With unlimited pool of public money to fight legal case and proving the intent on most of the arrangements will not be difficult for them. I am sure, many people will be using these arrangements now and ATO most likely aware of this. Just have to make you are not the one they'll take court to.....frankly they have many bigger fish to fry now than these arrangements but surely time will come for these as well....