Draft Taxation Determination TD 2011/D8 has been released for comment.
TD 2011/D8 states that an investment loan interest payment arrangement is capable of attracting the operation of Part IVA of the Income Tax Assessment Act 1936 (the tax avoidance provisions).
An investment loan interest payment arrangement will exhibit all or most of the features set out as follows:
(a) The taxpayer(s) own at least two properties: one property is the taxpayer(s)’ residence and the other is used to derive rent (‘investment property’).
(b) The taxpayer(s) have an outstanding loan which was used to acquire the residence (or refinance an earlier loan used to acquire the residence) (‘home loan’), an outstanding loan which was used to acquire the investment property (or refinance an earlier loan used to acquire the investment property) (‘investment loan’) and a line of credit or similar borrowing facility with an approved limit (‘line of credit’). All three loan products are typically (but not always) provided by a single financial institution.
(c) The respective interest rates on the home loan and investment loan are typically at or about the same rate. The interest rate on the line of credit is typically (but not always) higher by a small margin (for example, 0.15%).
(d) The investment loan is typically an interest-only loan for a specified period with principal and interest repayments required thereafter, or the interest-only period may be extendable.
(e) The line of credit typically has no minimum monthly repayment obligations provided the balance remains below the approved limit. Alternatively, it may require minimum monthly repayments equal to the accrued interest.
(f) The home loan, investment loan and the line of credit are each secured against the taxpayer(s)’ residence and/or investment property.
(g) The line of credit is drawn down to pay the interest on the investment loan as it falls due. Where no repayments are required on the line of credit, the taxpayer(s) do not make any repayments, which results in interest on the line of credit being capitalised and compounded. Where monthly interest repayments are required on the line of credit, the taxpayer(s) meet such repayments from their cash flows.
(h) Typically all the taxpayer(s)’ cash inflows (including that which the taxpayer(s) otherwise might reasonably be expected to use to pay the interest on the investment loan) are deposited into their home loan or an ‘acceptable loan account offset account’,2 which has the effect of reducing the interest otherwise payable on the home loan.
(i) If the line of credit reaches its approved limit before the home loan has been repaid, the taxpayer(s) may apply to increase the limit on the line of credit in conjunction with a corresponding decrease in the available ‘redraw’ amount in the home loan.
The use of the line of credit to pay the interest on the investment loan results in interest on the investment loan, in effect, being capitalised and thus its payment deferred in order to enable the taxpayer(s) to repay an equivalent amount on the home loan.
Taxpayers who have entered into an investment loan interest payment arrangement have sought to claim deductions for the interest incurred on the line of credit under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).
The ATO concludes that if one or more of the parties that entered into or carried out the scheme did so for the dominant purpose of enabling the taxpayer(s) to obtain a tax benefit in connection with the scheme (and by using business income to pay off private debt),Part IVA applies to the scheme and the Commissioner would be entitled to determine that any deduction for the relevant interest incurred on the line of credit shall not be allowable to the taxpayer(s).
