OMG...Is this legal?

[kai41314]

Hi all,

I have a friend who is going to buy a $700K commercial property in NSW. Her mom will pay cash ($700K plus other expenses) for her. However, my friend discovered if she pays cash, she cannot claim tax deduction in the future. A conveyancer suggested her to make a borrowing contract between her and her mom and the interest rate can be higher than normal rate to maximize the tax benefit.

As a result, the solution looks like this:

1. $750K Interest Only Loan (interest rate 11%) from mom
2. My friend will pay $6,875 to her mom as interest
3. Her mom will save it and return to my friend
4. My friend can claim tax benefit for the interest (actually this is her saving because she can get it back).

Sounds amazing but is this legal???

 

[Aaron_C]

Yes but mum will pay tax on the interest income.

 

[nhg]

Why is it 11% interest?

Yes she won't be able to claim deduction which is why you borrow as much as you can and chuck the rest in an offset account.

 

[kai41314]

Yes but mum will pay tax on the interest income.

Her mom is retired and lives overseas.

 

[geoffw]

You cannot claim an interest deduction for capital expenditure. Even when you borrow you can only claim for the interest.

So either:
1. She pays cash, and receives no deductions, but has no other expenses
2. She borrows money from a friend, claims a deduction on the interest paid, and declares the income received as income. Net result, net tax payable is zero. The same as for option 1 but with more stuffing around.

 

[Terry_w]

OMG a conveyancer giving tax and legal advice!

The advice was illegal but the concept is legal. However there are many things to consider such as the taxation rate for a non resident, the requirement for withholding tax, terms of the agreement bankruptcy laws here and the country of the mum, death, asset protection, mortgages etc.

Non residents pay about 32.5% tax with no tax free threshold, though it may be lower for income from interest.

Mum needs her own legal advice as does the daughter.

 

[geoffw]

Terry. How would incurring an expense with a matching income benefit her? I'm just wanting to learn here.

 

[dan c]

Terry. How would incurring an expense with a matching income benefit her? I'm just wanting to learn here.

I think the income (mum giving the money back) would not be declared as income, rather it would be a 'loan' or a 'gift'.

A few grey areas here, me thinks.

 

[Terry_w]

Hi Geoff,

Ignoring the foreign element.

Say A had cash and wanted to buy a $700,000 property. There are a few options such as
1. A could pay cash
2. A could borrow from a bank and put the cash into a 100% offset
3. A could gift to mum and borrow back
4. A could gift to a discretionary trust and then borrow it back

1 would have little benefit except simplicity. If A lived in the property there would be little problems for the moment. But if A decided to keep this property and buy a new one to live in then the money would be tied up and she would have to borrow against this to buy the new one. Large loan on the new one with no interest deductible

Double whammy of
i) higher income from the rent = more tax
ii) higher non deductible loan for the new PPOR = more non deductible interest.

Less of an issue with commercial, but still an issue as the money is tied up.

2. This method is better, but she is still tying up 20% deposit. If A were to move then 20% would be stuck in the old property.

3. This could be better, but inflexible. Mum gets taxed on income received. What if mum gets divorced, money is hers - but ends up in the hands of her new ex husband. What if mum dies - ends up in the estate which is challenged by the ex husband.

4. This is the most flexible and strongest solution.
Gift to a trust of cash doesn't incurr any stamp duty or taxes. A gift is gone, no longer A's asset. But if A does go bankrupt this could possibly be clawed back. The longer ago the transaction was the stronger it will be.

Tax advantages can be changed to suit the circumstances. The trust could charge A no interest (depending on the terms of the trust) or market rate interest. This will depend on the situation. If it is a main residence then nil interest may be better. If it is investment then market rates would be better as this is a deduction to A. The rate could be more than normal bank rates depending on if the loan is secured by a mortgage or not.

This has 2 tax advantages
1. Higher deductions, potentially, for A, and
2. Diverts income into the trust which could then be distributed to other family members at much lower interest rates - possible nil.

The trust can also take security over the property such as
1. First mortgage, or
2. Second mortgage,
3. an equitable mortgage, ie not registered on title.
4. Caveat
etc
So if A is attacked then the property will be much more secured than if she held it in her own name.

If A died then the trust assets would also be much safer as the money would not fall into the will which could be challenged. (depends on a few things, in NSW it could be challenged).

 

[kai41314]

OMG a conveyancer giving tax and legal advice!

The advice was illegal but the concept is legal. However there are many things to consider such as the taxation rate for a non resident, the requirement for withholding tax, terms of the agreement bankruptcy laws here and the country of the mum, death, asset protection, mortgages etc.

Non residents pay about 32.5% tax with no tax free threshold, though it may be lower for income from interest.

Mum needs her own legal advice as does the daughter.

Hmmm...just called an accountant and he told me since the mum is not an Australian and doesn't live in Australia. She only needs to pay income tax in her country (income includes the interest from Australia). I am confused now.

 

[willfong]

http://www.ato.gov.au/businesses/content.aspx?menuid=0&doc=/content/50240.htm&page=12&H12

According to the above link your friend will have to withhold 10% of the interest paid to overseas payee.

 

[jingo]

Hi all,

I have a friend who is going to buy a $700K commercial property in NSW. Her mom will pay cash ($700K plus other expenses) for her. However, my friend discovered if she pays cash, she cannot claim tax deduction in the future. A conveyancer suggested her to make a borrowing contract between her and her mom and the interest rate can be higher than normal rate to maximize the tax benefit.

As a result, the solution looks like this:

1. $750K Interest Only Loan (interest rate 11%) from mom
2. My friend will pay $6,875 to her mom as interest
3. Her mom will save it and return to my friend
4. My friend can claim tax benefit for the interest (actually this is her saving because she can get it back).

Sounds amazing but is this legal???

If the building is new there may be significant depreciation that could significantly reduce the tax payable on the income received. Could be worth checking depreciation benefits out.

 

[ZachAnSel]

Risk > Rewards, but legal and achieveable

 

[geoffw]

Hmmm...just called an accountant and he told me since the mum is not an Australian and doesn't live in Australia. She only needs to pay income tax in her country (income includes the interest from Australia). I am confused now.

Would this depend on whether or not Australia has a reciprocal tax agreement with the country she lives in?

 

[Terry_w]

Would this depend on whether or not Australia has a reciprocal tax agreement with the country she lives in?

Not really. I think the withholding tax is different for different countries, but how the mum is taxed will depend on the rules back where she is a tax resident.

International tax is a complex area.