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Is capitalised interest deductable?

Discussion in 'Accounting, Tax & Legal' started by Sean, 27th Mar, 2006.

  1. Sean

    Sean Member

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    Hi all,
    Just a quick question.

    Is capitalised interest on a LOC and/or a margin loan tax deductable or does it have to be paid, in order to claim it?

    Also, am I correct in saying, interest pre-paid for next year is claimable in this years tax return?

    Thanks, Sean.
     
  2. D&K

    D&K Well-Known Member

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    Hi Sean,

    I don't feel to well qualified to answer this but I'll help where I can, this is definately one of those cases where you need to get advice from an accountant or two, because I have found the answer to be mixed.

    The simple answer: it depends, and it seems to depend mostly on the purpose by which the capitalised interest was incurred.

    If you go to the ATO website's tax rulings: http://law.ato.gov.au/atolaw/findldbatodocs.htm and search for "TR 98/22" you will get the ruling from the Hart's case.

    In this instance a structure was in place that is all important - an IP and PPOR were linked. The Hart's benefited from capitalising interest on their IP by directing all income to pay down their PPOR. The Tax Commisioner wasn't happy and the structure was deemed a tax avoidance scheme. There is a follow up ruling about the cost going into the CGT base, which was also disallowed. Essentially the purpose of the capitalisation of interest provided a reduction in the amount owed on a private account (ie their PPOR for which you can't normally claim tax on interest and you would pay tax on earning before paying it down).

    The use of the term "private account" seems to imply (to me at least) that if the reason was for re-investment, and you would end up paying tax on the earnings of that investment, then your probably OK. That is, the ATO doesn't care where you spend it (re-invest or private use) because you end up paying tax on it before you use it - instead of avoiding tax.

    I have another way of looking at it. The bank charges me interest at the start of the month, more interest acrues on that interest until about the 28th when the interest payment comes out. Hence for 3 weeks of the month the interest is being capitalised and that's similar to how majority of loans are probably paid (unless you pay on the exact day the interest is charged, or in advance).

    So I think the answer comes down to purpose and method. If you capitalise for investment, it seems OK. If you capitalise an investment but pay tax on the distribution before putting it to private use, then you're probably OK also. I figure this applies equally to asset classes, property and shares.

    Hopefully NickM will answer this thread and correct any errors I just made!

    HTH, Dave
     
  3. Alan

    Alan Well-Known Member

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    This is probably a VERY relevant question to many people on this Forum who intend to use this type of structure.

    Indeed, I wonder if Nick could provide some links to relevant rulings etc to clarify the situation?

    Thanks Nick. :)
     
  4. Simon

    Simon Well-Known Member

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    The answer I am continually told is that it is not able to be claimed for property but it is quite OK to capitalise interest on a margin loan?

    If so use of a good income fund with high gearing would be very useful for reducing PPOR debt quickly.

    I would also love advoce from Nick on this.

    Cheers,
     
  5. D&K

    D&K Well-Known Member

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    If you want to refer to page 56 of this month's API you will se an example of extending the loan to pay negative gearing expenses, which will includes unpaid interest (hence capitalising) and other fees. Like LOE, you still have to pay the tax on interest on loans where the money is for private (non-income producing) use.

    Same as negative gearing and CGT laws apply across both shares and property, I don't think the asset class makes that much of a difference when it comes to paying or not paying tax on the earnings. :)

    Capitalising interest for property has probably been made murky by the Hart's case, because the loans for the two items of the same asset class were merged as sub-accounts, even though one was income producing and one was not (doesn't make much difference to the lender does it?). You just don't get a loan structure for different asset classes in one, hence with shares the different asset classes (if paying PPOR) prevent this merge from happening due to the loan products. It's also a lot harder to use shares for private use without paying tax, you have to pay tax on the dividends (or the company does by franking); you can't shift the earning to a PPOR without paying tax.

    The main issue, I believe, is the purpose of capitalising interest (eg to avoid tax), not the asset class. The Hart's case ruling was deliberately not specific to property. Again, I will be happy to be corrected by a more learned authority on the subject. :eek:

    Dave
     
  6. talbashan

    talbashan Well-Known Member

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    hi there,
    i have a margin loan with the interest capitalised. i have been told (twice) by the navra people that it is tax deductable. i have queried this twice and was told the same answer.
    tomorrow i am going to see my accountant for the first time since starting this loan so i'll have another angle on this. hopefuly a positive one. i'll let you know.
    cheers
    tal
     
  7. Sean

    Sean Member

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    Talbashan,
    So, how'd you go?
     
  8. Jacque

    Jacque Team InvestEd

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    I'm sure he would if he could, but he's sunning himself on a much deserved annual break at the moment! Will be back in action after mid July :)
     
  9. Karen

    Karen New Member

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    Hi Sean,

    Please find some links to articles below in relation to split loans and capitalised interest this may give you some insight to what is deductible, how much is deductible, and how to go about it with the ATO.

    www.ato.gov.au/corporate/content.asp?doc=/content/mr2004034.htm
    http://moneymanager.smh.com.au/articles/2004/06/09/1086726492283.html
    http://moneymanager.smh.com.au/articles/2003/04/01/1048962747450.html

    In relation to pre-paid interest if you have already pre-paid your interest for next financial year or you are making a payment before 30 June 2006 you are able to claim it in your 2006 tax return.

    I hope this helps!!
     
  10. MrDarcy

    MrDarcy Well-Known Member

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    It can be deductable, but I think each case might be a little different. I have a private ruling for a form of capitalising interest, details in this thread. Maybe that will help you.
     
  11. Jacque

    Jacque Team InvestEd

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    Thanks Karen! It's helpful and practical posts like this that make this forum so worthwhile for all of us :)
     
  12. Redwing

    Redwing Well-Known Member

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    *bump*

    Mr Darcy's thread was very informative especially considering it applies to his PPoR as well, however, I keep on hearing the same as Simon from many Mortgage Brokers etc in that if you use a LOC to pay the interest on a IP Loan then you cannot claim the LOC interest?

    Is there any updates on this for the benefit of the Forum?

    RedWing
     
  13. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    That's pretty straight forward. The purpose of the borrowing is for investment, therefore it is deductible. However, ONLY that portion of the interest that is related to that borrowed investment money is deductible - if the LOC was also used for private purposes, then you'd need to be careful to work out which part of the interest is for which part.

    But it actually gets worse ... if you then make payments into the LOC, you can't arbitrarily choose which part of the LOC (deductible vs non-deductible) to make the payment against ... indeed the ATO will likely deem that you have paid down the portion you were using for investment. In other words ... proceed with caution !

    For these reasons, it's not as simple as just apportioning the deductible interest component ... and I personally recommend that you do NOT take this approach (or spend some time carefully planning how you will deal with it with your tax advisor). A better method would be to split the LOC into two facilities (most banks will let you do this), and use one only for personal and the other only for investment - that way it's pretty cut-and-dried which is which.

    Either way, I also recommend that you do NOT rely on your mortgage broker for tax advice. Get tax advice from a tax advisor !!!
     
  14. Redwing

    Redwing Well-Known Member

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    Thanks Sim,

    The LOC is set up for Investment purposes only, being:

    • Investing in a Managed Fund for Incme and Growth (see how year one goes then look atleverage).
    • Use as a Deposit on the next IP(including purchasing costs).
    • Keep a portion as a Safety Buffer
    However, if i wanted to pre-pay the first years interest on the new IP Loan and give myself some breathing space for any reason (Monthly Interest payments would be less on the LOC than the Loan ) would this LOC interest be tax deductible?

    If not then hopefully the Capital Growth over that year would balance out the interest payment from the LOC.

    Could you then etrapolate that out and pre-pay Five years Interest on the IP Loan?

    RedWing