Split loan financing loophole closed for investment properties


The Australian Taxation Office has cracked down on a strategy that was allowing people buying a home and an investment property to pay off their home loan more quickly by channelling all repayments into that mortgage while letting interest build up on the investment loan.

The strategy became widespread in the 1990s and early 2000s when banks started offering “split loans” or “linked loans”, whereby investors could use the same borrowing facility to finance the purchase of both their home and an investment property. Under those facilities, all loan repayments were applied to the home mortgage component, but none were allocated to the investment loan.

That rapidly reduced the amount owed and the interest charged on the home loan component. Meanwhile the interest accrued on the investment property loan increased and compounded, with interest being charged on interest.

This benefited many people because they were claiming the increasing interest on the investment loan as a tax deduction.

Loophole closed

But in 2004 the strategy was challenged in the High Court by the Commissioner of Taxation. The court’s decision was that the main purpose of the split or linked loan arrangement was to avoid tax, which effectively put an end to the strategy.

However the case left open a loophole that has allowed people to execute basically the same strategy using two separate loans. But the ATO released a tax determination in March closing the loophole and preventing any variation of the arrangements.

While it’s not clear how many people had been taking advantage of the arrangements, it must have been a significant number for the ATO to issue a tax determination on the subject, says Eddie Chung, partner with tax firm BDO.

It applies retrospectively, he adds, which means anyone who has claimed a tax deduction on interest capitalised and did not make repayments against the loan may have to adjust their previous years’ tax returns and pay extra tax.

“The commissioner has powers to review past [years’ tax] returns but there’s a limit to the years,” Chung says. “They can go back through the last four years and deny the interest that has been claimed.”

Identification procedure 

The Tax Office can identify people who have been using loans in that way by asking lenders offering the facilities for lists of customers using them. It can also screen its own records for taxpayers whose claims for interest deductions on investment loans have gone up from year to year. If the investment loan was being repaid, or the interest at least was being repaid, the size of claim for interest deductions should reduce or stay the same from year to year.

The biggest risk now for people who have been using the strategy is that the ATO detects it before they do. Chung says investors who voluntarily disclose they have been using the tax strategy, and pay the required tax, are given concessions. But if the ATO picks it up in an audit, penalties may apply.

“There are different ‘levels’ – from mistakes to recklessness – and [penalties] can go up to double the amount of the tax,” Chung says.

Penalties charged in addition to the tax owed range from 25 per cent to 100 per cent of the tax payable.

HLB Mann Judd tax partner Peter Bembrick says it is still wise for those who have non-tax-deductible debts, such as a home mortgage, to repay the loan as quickly as possible. While the tax determination prevents one way of fast-tracking home loan repayments, there is still nothing to stop investors paying only the interest on their investment loan and diverting any spare cash after those repayments towards the home mortgage.

“You have just got to be clear how you are structuring it . . . make sure you are paying the interest on the investment portion rather than capitalising it,” says Bembrick.

Source: afr.com


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