offset accounts - NOT tax advantages!

From: Anonymous


Hi everyone,

I've been reading this forum for a while now, and was very interested in the previous posts regarding some of the tax advantages in using an offset account. In particular, I was interested in the strategy of using an interest only loan with an offset account for one's PPOR. Then, when you decided to upgrade and buy a new PPOR, but also want to keep the 1st one as an IP, you can take the money out of the offset account and use that for your deposit. However, the money still remaining in the interest only loan will now be fully tax deductible as this is now an IP. I was interested in using this strategy for my own situation and was about to re-finance from my P&I loan to an offset account on an IO loan.

However, today I went to see an accountant just to make sure this was legitimate. He's pretty well educated ( has a B.Com, MComm, CPA and FTIA) and evidently has a lot over 20 years experience with IPs (owning several of his own too).

This accountant told me that the above strategy is absolutely NOT legitimate. He told me that since money in the offset account IS effectively reducing the balance upon which the interest is calculated, then that money is effectively diluting the tax deductible proportion of the loan. Not only that, but since the bank treats the money in the offset account in this way, then effectively you CANNOT separate money in the offset account from the home loan in the eyes of the ATO.

A lot of people on this forum have said that offset accounts are a great way to "park" extra funds and so reduce the interest payable on an IP loan, but allowing you the flexibility to withdraw the money later on without effectively reducing the tax deductible portion of your loan. It sounds like having your cake and eating it too which, as this accountant today pointed out to me, the ATO is not dumb enough to let you get away with.

So who is correct? And if you believe in the tax benefits of offset accounts, can you point me to any tax laws etc that would back that up?

Cheers

Anon

Reply: 1
From: Always Learning


I only seek advise from specialist professionals: such as H&R Block!
-: Dale may also be able to help ;-)
<p>
I think your accountant is either getting confused between a redraw facility and an offset account, or is not confused, and just plain wrong.

Reply: 2
From: Rolf Latham


Hi Anon

All professionals have different opinions.

You will find too that, many accountants are now suggesting that a trust is no longer worthwhile because the tax treatment of trusts HAD changed.

Obviously some tax advisors are living in the future.

Up to today an offset account is a legit way of reducing your interest bill without reducing your loan principal. I have yet to be presented with evidence to the contrary, but you must trust your licensed and qualified advisor.

I wonder what other anti-avoidance measures are about to be foisted upon us ?

Ta

Rolf

Reply: 2.1
From: M O N T O


Rolf,

"You will find too that, many accountants are now suggesting that a trust is no longer worthwhile because the tax treatment of trusts HAD changed. "

Would you explain a bit more about what had changed and why it's no longer worthwhile. It's interesting to know.

Reply: 3
From: PT Bear


I don't see why the ATO shouldn't treat an offset account any differently from the way most people expect them too. The purpose of the account is to reduce interest. This does dilute the tax benefit of that interest, but you should be able to take that money back as you please.

In most cases the money in these accounts is from something like a PAYE salary, so the tax has already been paid on it. Why not be able to use it for what you like?

This is only Bear logic - not accountant advice.

I also found out today that a loan I set up with an offset account, doesn't really have an offset account - despite the bank telling me that it was when I opened it. I've only had the loan a few months, so the damage is minimal, but the broker and the loan manager are going to have a few things to answer for tomorrow. I'll be checking what they set up a lot more closely in future.

PT_Bear

Reply: 3.1
From: Anonymous


Hello,

I also can't understand why the ATO should treat money in an offset account differently to putting money straight into the home loan. I mean, you could argue that they are separate items. But the fact that money in the offset account is offset against the loan means your intention of putting the money into the account WAS to effectively reduce the home loan. Practically the same as if you had put the money directly into the home loan in the first place.

Therefore, if you then go and withdraw the money from the offset account for your new PPOR, the ATO could argue that the remainig loan on your first PPOR (which is now an IP) has been diluted by all of the money you put into the offset account.

Does this make sense?

Anon

Reply: 2.1.1
From: Sim' Hampel


On 7/1/02 9:08:00 PM, M O N T O wrote:
>Rolf,
>
>"You will find too that, many
>accountants are now suggesting
>that a trust is no longer
>worthwhile because the tax
>treatment of trusts HAD
>changed. "
>
>Would you explain a bit more
>about what had changed and why
>it's no longer worthwhile.
>It's interesting to know.

Rolf was pointing out that there were some PROPOSED changes to trusts, which if they had come into effect (they haven't yet and possibly never will !), then trusts may not be the most suitable structure. Rolf's point was that some accountants were dispensing advice based on a proposal, not on reality.

Reply: 3.2
From: Sim' Hampel


On 7/1/02 9:25:00 PM, PT Bear wrote:
>
>I also found out today that a
>loan I set up with an offset
>account, doesn't really have
>an offset account - despite
>the bank telling me that it
>was when I opened it.

I've heard of this kind of practice. Naughty !

Reply: 3.1.1
From: Sim' Hampel


*sigh* why do we have to have the same arguments over and over again ?

Tax deductibility is determined by the use of the borrowed funds.

The act of borrowing money is facilitated by withdrawing (drawing down) money from your loan account.

Withdrawing money from my offset account is not borrowing.

If I place money into my offset account, my bank gives me a discount on my offset loan interest in lieu of paying me interest on the money in the offset account.

The balance of my loan account does NOT change as a result of deposits into my offset account.

If I withdraw money from my loan account, I am borrowing money.

If I withdraw money from my offset account, I am NOT borrowing money, nor has the balance of my loan account changed.

One caveat though is to be wary of traps like PT Bear found himself in, where the "offset" account really wasn't. The accounts have to be totally separate.

The key to the whole thing being that the bank is giving me a discount on my loan interest costs in lieu of paying me interest on my savings. They are NOT reducing my loan balance.

Reply: 3.2.1
From: KJL .


This happened to me with a major bank. When I discovered it, I wrote and told them that they had represented at the time of my taking the loan that it was an offset account, and please explain.

I also asked them to tell me what my next level of recourse was if I wasn't happy with their reply.

Result: a full spreadsheet calculation from the Bank of the effect of not offsetting my accounts for the relevant period, together with a $1,300 immediate reduction from the mortgage. Sometimes it pays to check and whinge!

KJL

Reply: 4
From: Sim' Hampel


On 7/1/02 6:58:00 PM, Anonymous wrote:
>
>And if you
>believe in the tax benefits of
>offset accounts

Tax benefits ? Offset accounts ? Hangon a second... I am LOSING tax benefits by using an offset account... when I have money parked in my offset account, I pay less interest, so I claim less of a deduction at tax time.

If I put that cash elsewhere, I would claim the full deduction because I pay more interest. The taxman actually wins on this deal !

Even if I withdraw the money from my offset account later, I have still claimed less of a deduction overall.

Reply: 4.1
From: Anonymous


hello,
sim, by "tax benefits" I meant the benefit derived once one moves out of the PPOR, converts it into an IP, and then the remaining loan then becomes tax deductible. This to me would be the benefit of using an offset account in my example. ie, I get to reduce the interest payable while living in the property, but still preserve a large loan than once I leave will be tax deductible. Or more simply, the "tax benefit" of using an offset account is that you (supposedly) do not interfere with the tax deductible component of a loan.

I understand what you mean about borrowed funds and that taking money from the offset account is not borrowing. My accountant's point though (I think) is that money in the offset account is effectively being used to pay off the mortgage. He reckons that you might try to "dress up" the situation as one where the bank is paying you interest in lieu, but at the end of the day the overall effect is that the more money you put in the offset account, the less interest you pay on your mortgage. Especially with an interest only loan this becomes glaringly obvious, and surely the ATO must see this!

Anon

Reply: 4.1.1
From: Waverly Bay


Below are my thoughts on some ways the ATO could deny the investor the tax benefits of offset arrangements. My thoughts only !

ANTI AVOIDANCE PROVISIONS ("AAP")

Rolf rightly flagged this as something to think about - as the ATO loooooovvvvveeee the anti avoidance provisions ! For the AAP to apply, the ATO would need to argue along the lines that the offset account used in conjunction with the IP loan constitutes an
"arrangement" the "sole or dominant purpose" of which is to avoid tax.

Yes ... offset accounts do result in tax benefits that are not available in say a redraw arrangement. But is the minimisation of tax the "sole or dominant purpose" behind why investors enter into offset arrangements?

I would argue ... NO.

My submission to the ATO would be that offset accounts against IP loans offer primarily COMMERCIAL benefits to the investor...and that any tax minimisation benefits are merely incidental.

1) The return on surplus funds parked in an offset account is much higher than the return available on an ordinary savings account or even a term deposit (but with the same risk profile). (.....Higher returns of course means MORE tax to the ATO !)

2) The higher returns offered by the offset arrangements does not come at the cost of flexibility. Investors have enormous flexibility to access the surplus funds parked in the offset- in fact far more flexibility than would otherwise be available for say term deposits or through a redraw facility (which often require minimum redraw amounts, application to be made for redraw etc).

3) Offset arrangements are never marketed as tax minimisation arrangements. The material on offset arrangement is mostly directed to assisting Owner occupiers pay off their PPOR loans faster.

"SUBSTANCE OVER FORM"

I think this is the approach of Anon's accountant (see first post). On a "substance over form" approach, the ATO could argue that funds parked in an offset which is linked to the IP loan constitutes "in substance" a repayment of the loan ..and that conversely, the withdrawal of funds from that offset constitutes "in substance" the advancement of a new loan. The success of this argument would hinge very much on the strong relationship/link between the offset account and the loan - so much so that both could be read as being part of "one" larger loan arrangement.

Again, i would be disappointed if this line of reasoning was taken up by the ATO. Anon's accountant was right to raise this as a "risk factor" given the very aggressive nature of the ATO.

If the offset account was operating merely as some conduit which did not place the funds of the investor at risk but served only to milk tax benefits... i could see the merit of the "substance over form" argument. However, this is not the case. As mentioned above, the offset account first and foremost brings about real commercial benefits to the IP investor.

* * * *

cheers

Waverly

Reply: 4.1.1.1
From: Dale Gatherum-Goss


Hi wb!

What a great post!!!! Thank you for bringing a great deal of common sense and practicality to this debate.

It's a pity that some people have entered into this discussion with a closed mind.

Dale

Reply: 4.1.1.1.1
From: Sim' Hampel


Thanks wb, I was thinking of trying to use a "commercial benefit" reasoning to back up my stand point, but you did it much better than I would have. Well done.

Reply: 4.1.1.1.1.1
From: Dale Gatherum-Goss


Hi

Further to wb's post, it struck me that our anonymous friend has not taken into account what the tax office might have already considered.

For example, the tax office have issues two rulings that deal with very similar circumstances:

TR 1999/D3
TR 2000/2

Neither are precisely cover this issue, but, both give a reasonably clear indication of how the tax office are thinking.

I trust this helps

Dale

Reply: 4.1.1.2
From: Dale Gatherum-Goss


Me again

As you can probably guess by now, this thread has pissed me off:

a. because of the anonymity of the person who then expects us to take them seriously, and
b. because of the ignorance that might not allow someone to use the law to their advantage.

Anyway, further to part IVA, the tax office considered this very issue in their own ruling TR 93/6 and said, quote:

"(x)
Is there a tax avoidance arrangement to which Part IVA applies?
24. In the acceptable loan account offset arrangements described in paragraphs 3 to 7, Part IVA does not apply. Although there may be a tax benefit in the arrangement, we consider that the conclusion required by paragraph 177D(b) cannot be made. That is, having regard to the matters listed in subparagraphs (i) to (viii) of paragraph 177D(b), the conclusion that the customer opened the account or accounts for the sole or dominant purpose of obtaining the tax benefit cannot be drawn."

Again, I trust this helps put this argument to rest.

Dale

Reply: 4.1.1.3
From: Rolf Latham


Hi WB

Good post.

My view on advice given by Anons accountant remains as it will do. Different professionals have different opinions and hence the need for a professional.

While it is wise to advise a client of the risks involved in any strategy, I feel it is important for that advise on risks to also carry some idea of how likely it is to affect THAT person.

Dont invest in property because a government may introduce legislation to minimise the effects of negative gearing.

Dont use a trust structure because the government may introduce legislation to treat them like companies

Dont use a P/L structure for your business because you may have to pay tax under a PAYG regime.

Dont buy an investment property or invest in shares until your home is paid off and you have saved a deposit.

Dont get married because more than half of marriages end in divorce ,......... now Im getting off track, but I think you get my point.

The list could go on on. There will always be more reasons why we cant or should not do things in life because of the risks associated with them. Thank heavens for discussions and second opinions.



Rolf

Reply: 4.1.1.2.1
From: Rolf Latham


Dale

She's Not anon, shes form the ATO sussing us out )


Rolf

New (financial) Year's Resolution

Reply: 4.1.1.2.2
From: Michael G


Dale,

I don't think I've ever heard you pissed off. Is this a New (Financial) Year's resolution?

By the way, what are people's New (financial) Year's resolutions?

Mine would be to make wraps work seriously for me.

Michael G