Paying Interest in Advance

[troyhunt]

Hi folks, just wondering if anyone has any experience with paying interest in advance for the purpose of brining deductions forward into an earlier financial year. In particular, I’m interested in how this works for IO variable loans. What are the implications of say, paying all the 2010 interest before the end of the 09 year and how are calculations managed when rates are likely to fluctuate over that period? Also, do you typically get hit with bank charges and if so, what sort of numbers?

Thanks!

 

[TheDoctor]

I don't think it can be done with a variable loan. It would have to be a fixed loan so that the interest payments can be predetermined.

 

[wylie]

We have done this for a while, and will be doing so again this year to bring our tax costs into this financial year.

Our loans are IO and were variable until the first year we prepaid interest. In order to prepay, we must fix the loan for a year or more and pay one year's interest up front. Last time we fixed for two years so paid one year's interest in June and another year's interest the next June.

We also prepay rates, and have prepaid land tax in previous years.

We are on a professional package so no cost, but our broker starts the ball rolling the first week in May because it involves new documentation so is not something to be left to the last minute.

 

[INVSTOR]

Wylie, do you get a discount from your bank for prepaying interest?

 

[twodogs]

Wylie, do you get a discount from your bank for prepaying interest?

I understand that you must get a discount in order for there to be a valid "commercial" reason to prepay the interest, else the risk that the transaction is predominately for tax reasons etc etc.....

I have been prepaying for years but not this year (I do not need the losses!) and I'm glad to out of the cycle. Deferring tax is good as you get cash flow now and possibly pay less tax if the rates decrease, but it's a hard cycle to get out of without increasing the tax paid in the year you stop. I had to borrow my prepaid interest last year as I did not have the cash, and while such capitalising of interest has it's place, not in the current environment thank you.

 

[Rob G.]

Capitalising interest against prepaid rates ?

I would love to hear your reasonably arguable position for that one !

Cheers,

Rob

 

[wylie]

Wylie, do you get a discount from your bank for prepaying interest?

We have to fix the loan at the rate the bank is offering for whichever length of time we fix for.

I don't know if Rob G's comment about capitalising interest against prepaid rates is meant for me, or the post following mine.

 

[Rob G.]

I don't know if Rob G's comment about capitalising interest against prepaid rates is meant for me, or the post following mine.

twodogs comments about capitalising interest.

Additional borrowing to prepay, which is essentially a discretionary expenditure, would make for an interesting case.

Cheers,

Rob

 

[keithj]

twodogs comments about capitalising interest.

Additional borrowing to prepay, which is essentially a discretionary expenditure, would make for an interesting case.

Like twodogs, I've borrowed to prepay interest. The business case is that the bank offered a (small) discount for prepaying. And borrowing to pay interest (capitalising it) is a normal business expense - I don't consider it discretionary. I've done it with both IP & shares.

 

[Rob G.]

Like twodogs, I've borrowed to prepay interest. The business case is that the bank offered a (small) discount for prepaying. And borrowing to pay interest (capitalising it) is a normal business expense - I don't consider it discretionary. I've done it with both IP & shares.

TR 97/7: Bills that have not yet fallen due under contract or by performance are not yet incurred and normally cannot be deducted on an accrual basis, but when actually paid since they are "discretionary expenditure".

The Commissioner is sensitive enough to capitalising interest where it amounts to something less than acquiring another asset.

For instance TD 2008/27 states that he does not rely on the purpose of the original loan, but considers the capitalised amount as a new borrowing for which the reason needs to be clear.

Therefore if you can display an objective purpose for borrowing to pay what is at the moment discretionary expenditure (such as the discount on early payment exceeding the compond interest expense) then that is reasonable.

However, if it merely appears to be borrowing to fund an early tax deduction then that sounds a bit too close to Fletcher's case for my comfort zone.

Fletcher's case was also exploiting a timing mismatch by claiming deductions early - albeit on an arrangement that may not eventuate in sufficient income at all. But nevertheless, I would feel better with a private ruling regarding details of my particular circumstances **if it did not stand on its own commercial merit**.

Cheers,

Rob

 

[twodogs]

Capitalising interest against prepaid rates ?

I would love to hear your reasonably arguable position for that one !

Cheers,

Rob

I've never heard of councils' accepting rates before they bill them, or even know how much they will be. Got me a tad curious too....

 

[wylie]

We have prepaid rates two ways, one by simply multiplying the previous quarter by four and other times by calling the council to get a quote for a year's rates in advance. The rates we have just paid were the smallish amount left over after having prepaid in June last year. They slightly underestimate rather than have us find we have overpaid.

 

[twodogs]

We have prepaid rates two ways, one by simply multiplying the previous quarter by four and other times by calling the council to get a quote for a year's rates in advance. The rates we have just paid were the smallish amount left over after having prepaid in June last year. They slightly underestimate rather than have us find we have overpaid.

Is there any commercial reason for doing this, beside a tax advantage ?

 

[BV]

Is there any commercial reason for doing this, beside a tax advantage ?

do you save the annual rate increases or does the council ask you to pay the difference later?

 

[Rob G.]

Is there any commercial reason for doing this, beside a tax advantage ?

TR 97/7 example 3.

twodogs - I love your questions!

This one is then leading to why you shouldn't borrow to prepay and then capitalise the interest for the year.

Cheers,

Rob

 

[twodogs]

TR 97/7 example 3.

twodogs - I love your questions!

This one is then leading to why you shouldn't borrow to prepay and then capitalise the interest for the year.

Cheers,

Rob

I had previously obtained a private ruling for the deductions (I may have posted detail on this some time back, can't recall) and it was not done as part of any plan or structure at that time. In the wild past I may have, but not any more.

However, as I wanted to prepay the interest (for the commercial advantage of a 0.1% discount not the tax deduction of course...) it had to come from re-draw on a loan, ie borrowed, as I didn't have a lazy 30K at hand. My private ruling covered this however I must add that I did not also request a ruling under Part IV as I didn't know any better.

Borrowing lump sums to fund prepaid interest is for the young and aggressive and could be the subject of a whole other thread. As for tax deducibility I'm OK with it but document your actions and commercial reasons, may a PR too, to cover one's **** if the time of tax reckoning descends upon you.