Capitalised Interest - Recent Court case

[DaleGG]

Hi

In a recent court case, a judge was asked to consider whether interest capitalised over a 10 year period was tax deductible, or not.

In short, he held that the nature of the interest had not changed; it still held its character as an outgoing incurred in earning the tax payers income.

Specifically, he commented that "despite the inability to pay the interest, the nature and character of the interest liability did not change and the capitalised interest was not of a capital nature"

I thought it might be worth mentioning this case. It is important.

Have fun
Dale

 

[Twitch]

Hi, so in layman speak, does this mean it IS fully tax deducable as an expense?

 

[asdf]

Thats great news Dale. Do you know if it was on appeal or just a District Court decision? Would you have the citation by any chance? Thanks again.

 

[DaleGG]

Hi

Yes, based on the court case it would appear that all the interest should be tax deductible.

No, I am not aware of any appeal ....yet. It is still early days.

The court case is:

R&D Holdings Pty Ltd v DFC of T [2006] FCA 981

Have fun
Dale

 

[gooram]

This is good news, but while the tax dept going are going to continue to take people to court over this, it may not be worth it.
Depends alot on the size of your portfolio I suppose, and how much you stand to gain from capitalising interest.

Anyone out there actively doing this? Mum's the word

 

[MichaelW]

Dale,

Many thanks. I am capitalising the interest on my margin loan for my managed funds and the bill is some $20K per annum. So its great to know for sure that it is still deductible against the earnings of that fund.

I must admit to always assuming it was. Never occurred to me that because it was capitalised it might not be deductible. The judge was right, its still a legitimate expense incurred against a deductible loan.

Cheers,
Michael.

 

[Terryw]

Here is a link to that case:
http://www.austlii.edu.au/au/cases/cth/federal_ct/2006/981.html

 

[asdf]

In order for this to work, you will need to keep a very clean audit trail. This is where the ATO will pick you up on. Any intermingling of funds will probably be sufficient cause to set this aside.

I am yet to find an account through any of the lenders which you're be able to direct debit the LOC/loan account from. Usually you have to take money out of LOC into a savings account or pay out directly. This makes it difficult for direct debit payments of your IP interest payments. Also if you had a P&I IP loan, this will not work as I'm not sure how you would apportion it for ATO purposes. As always, theory is always great but the banks can't just flick a switch to accomodate our every whim. I'm still working on the process though but if anyone has a cleaner way to do this, please feel free to share. BTW, when turning bad debt to good, all you're doing is getting a tax deduction for it so with most people paying 30% tax, it still costs you 70% but better in your pocket than Carmody's I say.

With the ML interest capitalisation issues, has anyone withdrawn money from their ML account into your savings account for day to day use....?

 

[twodogs]

This is good news, but while the tax dept going are going to continue to take people to court over this, it may not be worth it.
Depends alot on the size of your portfolio I suppose, and how much you stand to gain from capitalising interest.

Anyone out there actively doing this? Mum's the word

Mum not required.

I am capitalising interest on property and MF loans and have a private ruling that says it's OK to deduct interest costs on the loans for pay for the interest. I suggest arrange your affairs cleanly, document well and apply for a private ruling. It took me 2 weeks and I did it myself.

Why am I doing this ? I borrowed over $60k in interest last FY, and now that's an extra $60k cash flow I have to put to work elseware such as reducing non-deductable debt, ie transforming non-deductable debt to deducable debt

 

[MichaelW]

Why am I doing this ? I borrowed over $60k in interest last FY, and now that's an extra $60k cash flow I have to put to work elseware such as reducing non-deductable debt, ie transforming non-deductable debt to deducable debt

Maniyak,

I didn't quite understand this point. Did you mean to say: "I incurred $60K of capitalised interest on my investment borrowings last year. As a result of my private ruling this is now deductable so I can get $20K odd back which I can then put to use transforming non-deductable debt to deductable debt?"

i.e. You didn't borrow over $60K in interest, what you did was incur $60K of interest on your deductable borrowings? And you couldn't put the full $60K to work anyway as all it would mean is that this interest is deductable and you'd get a tax return at your marginal tax rate.

Is that correct?

Cheers,
Michael.

 

[twodogs]

Hi Michael,

No connection with marginal rates or the like here. I was only describing that by borrowing my interest expenses, I have more cash flow to reduce my non-deductable debt. Many people also do the same with property expenses, my point was it can also be OK with interest.

- I borrowed $60k to pay for my ongoing investment interest costs (mostly pre-paid)

- this increased my deductable debt

- over the year I have more cash because not paying monthly interest bills

- using that spare cash to pay down my home loan

- this is decreasing non-deductable debt

 

[MichaelW]

Maniyak,

OK, now I understand. I mistook the post to relate to the whole capitalised interest deductability question.

Sounds like a good strategy.

Cheers mate,
Michael.

 

[FrankGrimes]

Using a margin loan and letting it capitalise and using the income from the fund/shares/whatever to pay down your PPOR seems like a very easy way to transform non deductable debt into deductable? I thought ATO would be all over this.

Shh don't tell them

 

[gooram]

Maniyak,

Have you calculated exactly how much this strategy is saving you per annum? I'd be interested to know the figures if you care to share.

Also - what is involved in getting a private ruling? Is it a standard procedure?

For those that are successfully doing this, how are your finances structured? How do you get around the complications that asdf has found?

Thanks

 

[twodogs]

Maniyak,

Have you calculated exactly how much this strategy is saving you per annum? I'd be interested to know the figures if you care to share.

Nope, just an ongoing plan to reduce PPOR debt, this is A big part as it's my biggest expenditure other than capital

Also - what is involved in getting a private ruling? Is it a standard procedure?

Follow the application form on the ATO site and use that as a guide. Basically the format is you ask the questions you want, give details of how you will do it and fax it in. PM me for my application if you like.

 

[Mr. Fabulous]

Using a margin loan and letting it capitalise and using the income from the fund/shares/whatever to pay down your PPOR seems like a very easy way to transform non deductable debt into deductable? I thought ATO would be all over this.

Shh don't tell them

Frank, there's no need to be secret squirrel about it - it's perfectly legal and we advise clients to do it all the time. We call it debt recycling, where, like you stated, you use income from shares/managed funds to pay down PPOR debt, then draw out the equity, put it into shares/managed funds and use the income to pay down PPOR debt.

It's not for everyone and there are risks involved but it works for people.

Mark

 

[Glenn]

For the people currently using this strategy, have you spoken with current lenders about having interest capitalise and had this put in place or is it something only specialist lenders do?

Thanks

Glenn

 

[asdf]

For the people currently using this strategy, have you spoken with current lenders about having interest capitalise and had this put in place or is it something only specialist lenders do?

Thanks

Glenn

Currently normal home lending systems do not allow for capitalising of interest. Banks are running scared cos of issues in Firth's case but the next generation in lending is with super margin lending accounts. I'm not sure which bank is investing into this at the moment - I'm sure they all are but its going to be expensive. IT is one of their largest expenditures and they are not going to sink millions into a project with no certainty of income especially when you think the 95% of users out there are still only trying to get their head around home loans and credit cards. Only the structured products and margin lending areas are spearheading this. Some lenders already allow you to post unencumbered home as collateral but the ultimate service will be one loan over a multitude of assets and various sub-accounts so you can track each draw-down if you wish. They've got a long way to go.

 

[Mry]

The case is useful, but take care about the lessons you take from it.

The case was about interest for a building (which was considered trading stock) within a corporate structure.

We have discussed capitalised interest on the forum here before and how the ATO is alright with it - and this case confirms again that capitalised interest is claimable, but Part IVA (anti avoidance provisions) is still out there. There was no chance of Part IVA being applied here on the interest issue because the company has no private use to consider. As individuals, we do.