Split loans

[Jerry N]

G'day

Split Loans - how do they work?

Can someone shed some light on this issue.
Scenario:

Borrower has $150K home loan. Takes out $250K IP loan
Min. home loan payments - $1017
Min. IP payments - $1695

Borrower directs all payments ($2712) into home loan and allows interest on IP loan to build up.

Under this arrangement, the borrower pays out their home loan in 5.5 years compared to 25 years and potentially obtains a total $126K in extra tax deductions. At a tax rate of 43.5% that equates to a tax saving of around 55K.

I read this info in the September issue of Money Magazine.

Question1: Does this mean that the IP loan is not being paid off? Is this possible?

Question 2: Which finance industry offers this tax-effective mortgage?

 

[XBenX]

A1a Yes

A1b Yes, it is often termed capitalising interest - there has been a ruling in favour of the system/idea (but _BUT_ ATO are appealing it - tread very carefully - they aint happy ppl are doing this)

A2 - Many companies offer this type of loan, speak to your broker

 

[Rolf Latham]

hi JN

The IP loan actually grows, because you are capitalising interest to it, however the PPOR loan decreases rapidly

Almost all lenders have products that allow this type of arrangement if you use the right combination. You dont have to use the "split loan" facilities offered by a few resellers with premiums of up to 12 % on interest rate. The sales logic is that youre making a huge saving so the rate is "irrelevant", and the interest is deductible anyway.

Ta

Rolf

 

[Mike]

Rolf,

Is it possible to refinance to a split loan? I have a PPOR plus two IP's. Can I now restructure the loans to a split facility and keep the offset facility? Is it advisable to do this now or wait until the ATO's appeal is over? Is there an online calculator that demonstrates the advantage of capitalizing interest using the split loan method?

Regards, Mike

 

[Kevmeister]

XBenX:

You say "tread very carefully", but this to me seems a bit like being "a little bit pregnant". You either do this (in which case you may have to answer to the ATO), or you don't, in which case you won't (have to answer to the ATO).

So far there has been a judgement upholding someone's right to undertake this scheme. It's in appeal.

So can you jump in under the notion that this was deemed "legal" (even though it is being appealed) and use this as a legal standpoint if ATO tries to hassle you?

But, similarly, those people who started doing this before the ATO action commenced, what would their legal standpoint have been (probably along the lines of: "ATO hasn't said it is not *illegal*").

I'm curious what ATO's recourse can potentially be if (is it Heritage) loses the case on appeal? What is ATO's history on these types of actions, when in many situations the investor believes they are acting legally, especially when financial organisations are promoting the concept?

It might go on for so long that if we jump in now we might have our PPOR payed off before a result is known either way!

 

[XBenX]

kev : its not as black and white as you make out

We all know the rulng and the fact it is being appealed, by telling Jerry to tread very carefully i hoped to encourage the due diligence process so that the advantages/disadvatages are known and can be weighed up against the risk

The situation is this, you see the advantage - you take out one of these loans and you take a punt the ATO isnt going to backdate the ruling if it falls in their favour. Or you see the risks outweighing the positives and dont take one of these loans out - to me this decision is walking a tightrope - hence tread very carefully.

Its not something that I would be doing, even if I had a large PPOR debt - but maybe Im just risk averse ?

 

[Mike]

It might go on for so long that if we jump in now we might have our PPOR payed off before a result is known either way! - Kevin

That's exactly what I was thinking, Kevin. I didn't get involved in this because lenders were withdrawing their split loan products pending the outcome of the court case. The lenders always disagreed with the ATO's decision and now that they are releasing these products again why shouldn't we take advantage of it?

Regards, Mike

 

[XBenX]

The reason i wouldnt is incase they make the decision retrospective.

I havent really thought about it though because Im not in the situation to take advantage of it... lets see....

WORST CASE

ATO make changes retrospective and all capitalised interest amounts have to be repaid.... but you now have extra equity in your PPOR so you should be able to repay the capitalised interest from here...

So the cost to you is the extra interest that has compounded plus the extra interest rate that you've paid for the product.. any further ideas on this ?

 

[Kevmeister]

xbenx:

OK - I see what you were getting at now. I took your comments to mean more like "if you do this, be careful how you do this", hence my comments.

I'd still be interested to know what happens in cases like this (anyone). Given the "no mans land" this case is in at present it would seem likely to me (me, anyway) that the ATO would have to put an amnesty in place for a time to allow people to restructure themselves if it is proved to be disallowable.

A bit like pool fences - you can't just change the law in one day and then fine everybody who is not complying, or who didn't comply previously.

What concerns me is not how this issue itself turns out, but whether it potentially has ramifications for property investors. There is no doubt the ATO is less than happy because investors are using this technique to allow them to make their PPOR mortgage essentially tax deductible (in a roundabout way).

Interestingly, if you access the increased equity in an IP by way of refinancing, then spend the increased equity gain on a non-deductible item, then the interest on the loan (for that portion spent on the non-deductible item) is no longer deductible. From this perspective, I therefore see the ATO's point in disallowing this, because capitalising interest to spend on the PPOR is practically the same (but perhaps not legally) as redrawing capital from the IP to spend on a non-deductible item (the PPOR mortgage).

On the other hand, having an offset account attached to an investment property and then redrawing from the offset account is acceptable. The only difference is that the accounts in the latter case are physically indistinct so no physical drawdown from the loan account occurs. Yet in the case of interest capitalisation no physical drawdown occurs either.

My point is that even wording a ruling that takes account of the scenario precisely will be difficult in itself, especially when there are presumably also legitimate reasons for capitalising interest (eg. no tenant in premises).

 

[Kevmeister]

So the cost to you is the extra interest that has compounded plus the extra interest rate that you've paid for the product.. any further ideas on this ?

If they make the decision retrospective (which, as I pointed out, I find a little unlikely), then you are potentially no worse off than if you didn't do it, *assuming* that the split loan product you obtained did not charge an interest rate premium and *assuming* that the ATO does not charge penalties.

I could imagine a class-action being filed against financiers who were offering this product if the ATO wins its case. The financiers were not just providing the money in this circumstance, they were also promoting the "scheme" by which their product could be used to reduce your mortgage.

This is another reason why I think the ATO's response, even if they do win, will be somewhat soft and probably non-retrospective (ie. many investors potentially landed in this situation as a result of inappropriate advice from a probably-respected lending institution).

 

[XBenX]

ATO are pretty pissed that ppl are still doing this - immediately after they lost the case they appealed and started w/ the media releases stating that they were reviewing this and warning tax payers they didnt not agree w/ the judgement, etc.

When they are doing stuff like this ....

"Subject to the outcome of the special leave application, the Tax Office will continue to deny deductions for interest on the additional interest component in accordance with our public ruling on split loans (TR 1998 / 22)."

... without a ruling - it worries me what they will do if/when they do get a ruling !

 

[Rolf Latham]

Mike

yes you could depending on circumstances refinance to such a product.

BUT what is the commercial reason for doing so,................. my main concern is that you may get clobbered under Ainti Avoidance measures.

However, The savings over even a 12 month period could be quite substantial especially because of the reverse compound effect of such early savings.

With this I ALWAYS recommend you assess your risk with a competent but not woosy tax advisor and go forth accordingly.

ta

rolf

 

[geoffw]

Originally posted by XBenX
The reason i wouldnt is incase they make the decision retrospective.

I havent really thought about it though because Im not in the situation to take advantage of it... lets see....

WORST CASE

ATO make changes retrospective and all capitalised interest amounts have to be repaid.... but you now have extra equity in your PPOR so you should be able to repay the capitalised interest from here...

So the cost to you is the extra interest that has compounded plus the extra interest rate that you've paid for the product.. any further ideas on this ?

No, this is NOT the worst case. I know because I've been there (agricultural investments)

The worst case is that they make changes retrospective, and all capitalised amounts have to be repaid- AND THEN YOU GET FINED, AND HAVE TO PAY INTEREST ON OUTSTANDING AMOUNTS (interest was at 12% for me).

Kevmeister, you said

I'd still be interested to know what happens in cases like this (anyone). Given the "no mans land" this case is in at present it would seem likely to me (me, anyway) that the ATO would have to put an amnesty in place for a time to allow people to restructure themselves if it is proved to be disallowable.

You are assuming that the ATO is fair and reasonable. I went into an agricultural tax effective investment as a result of financial advice. I claimed a large deduction- and most of the refund went to that investment. That seemed OK-so I went into similar investments in two subsequent years. Close to four years after the original investment, the first investment was disallowed- the money I had sent to the investment was disregarded. I had to pay the entire deduction back to ATO- plus fines, plus interest. I ended up paying $50K for a $40K refund cheque- of which $3K I had kept. No amnesty, no restructure- until 18 months later after much political pressure and publicity- and even then, I will be out of pocket $20K- and that's only for the first year of three.

Hey, I'm not telling this story to be bitter. I've learnt, and I've come out a better person because of it. I'm telling the story to say- "don't stuff with the ATO. And certainly don't expect them to be fair and reasonable".

 

[Joe D]

Kevin

I'm in total agreement with Geoffw on this one. Don't assume the ATO is fair and reasonable. Carmody is out to make a name for himself and the ATO's taxpayer charter doesn't come into the equation.

Geoff, I'm sorry for your loss. I also was caught up in a similar mass marketed scheme and whilst I have settled on the matter and moved on, I believe the ATO's handling of the whole affair has been attrocious.

I fully support the group entitled AFTJ (Australians For Tax Justice) who have had a couple of significant wins against the ATO in respect of this matter. They are fighting on and whilst their cause doesn't get the publicity or political attention they deserve, they are doing a good job. For anyone interested their website is

www.aussietaxjustice.ws/

Best regards everyone for the New Year

Joe D

 

[Brian H]

I Totally agree with Geoff.
As I also was affected by the so called tax affective industry.Please be very careful about things like this.If it sounds too good to be true it probably is. As Geoff said about repayments to the tax office were unfair. Consider this that the ATO wanted to charge 50% penalties and 13.5% interest per annum. It wouldn't take long to pay them back double the initial benefit. I think you will find that if the tax office wins on the appeal and you have claimed the interest you may be a lot worse of than you think. On the other hand if the loose untill they get get the polliticians to change legislation it should be o.k to claim untill then.
Kind regards
Brian H

 

[XBenX]

excellent these are the kinds of things i was asking for

 

[Rolf Latham]

Hiya Brian

Not a legal person but the general view of the "learned" amongst us is that the appeal wont hold water AND is principally being conducted to throw the "switch" so that new legislation/regulation can be moved on.

I must say that I do not have many clients that have acted on the ruling, even though they have made initial enquiries, for the majority of them the potential risk was too great. For a couple they figured as many do - that the ATO would be "reasonable". Realistically, I have neither encouraged nor discouraged their decisions.

It is well know that the ATO is a law unto itself, I have met many a client with a nice capitalising tax bill as a result.

One of the classics is the Bud Plan thingy that was sold in the squillions. Certainly, I have learnt that for a middle to high income earner investing primarily for a tax benefit is frought with folly, no matter how solid the TR issued with the prospectus.



Ta

Rolf

 

[NIF]

I'm not sure about this but I thought the ATO ruling only applied to loans that are "split" as defined in the ruling. That is, they are issued together as a special product.

What if, for example, you had a home loan & an IP loan each with a different bank.

Then you obtain from the home loan bank a LOC secured on the home. You charge the interest on the IP loan to the LOC, effectively capitalising the interest on the IP loan. Meanwhile you direct all your spare cash flow into the home loan.

Am I correct in thinking that the ATO ruling doesn't apply to this situation, even though it has the same effect as a split loan ?

 

[Brian H]

Hi Rolf

In the end, the money that had to be paid back to the ATO was almost better than all the months of anguish and waiting to see what was going to happen. Its hard to express how much effect it has on ones life, Mentally.

Howdy NIF

Don't take my word for it but basically I think the same applies whether it is a split loan or two separate loans as the main principal in capitalization of interest of a tax deductable loan. I'm Sure the ATO would not care if you did it to your own non tax deductable loan.

sorry to be a downer but once bitten,twice shy.

kind regards

Brian H

 

[Brian H]

Sorry NIF

I just reread your post and misunderstood it the first time

you wrote

"Then you obtain from the home loan bank a LOC secured on the home. You charge the interest on the IP loan to the LOC, effectively capitalising the interest on the IP loan. Meanwhile you direct all your spare cash flow into the home loan".

As far as I can tell by this you as long as you dont claim the interest put in your personal homeloan, I can't see any problem. although I also can't see any advantage unless you were short on cashflow in the short term and needed to capitalize interest to use some of you equity you have built up in your home.
Please forgive me if I am wrong.

Kind Regards

Brian H