Reply: 1.1.1.1.1.1.1.2.1.1
From: Waverly Bay
Hi Richard
The purpose of my post was to inquire about the risk factors of your proposed structure. You seem to be suggesting that the PPOR loan should be separate and distinct from the IP loan/top up/discrete borrowing ("IP Loan"), and that it is this latter IP loan which is the direct "trigger" for the LMI. ie the LMI expenses are incurred as a result of the IP loan, the proceeds of which are used for an income producing purpose.
The relevant section of the tax legislation (section 25-25) allows a deduction for expenditure incurred by the taxpayer in borrowing money to the extent that the borrowed money is used for the purpose of producing assessable income. The "expenditure" in question is the LMI expenses which are passed on from the bank to the borrower.
You have taken the view that the LMI expenses are incurred as a result of the IP loan, and as such are deductible under this section. My original post raised whether there is a risk of the ATO arguing that the LMI expenses are incurred as a result of BOTH borrowings from the taxpayer - one of which is used for the PPOR purchase and the other for the IP purchase.
I believe there is still a real risk of this treatment from the ATO under your proposed structure. The legal form of your structure may indicate that it was the taking out of the IP loan which aroused the interest of the Mortgage Insurers to impose LMI. But the substance of your structure still very much points to the LMI being incurred by the taxpayer as a result of BOTH loans being taken out. The upshot would then be that the LMI costs would not be deductible to the extent that it was incurred by the taxpayer in borrowing money that is not used for incoming producing purposes (ie the PPOR loan). The Mortgage insurers do not impose the LMI by looking at the IP loan in isolation. The Mortgage Insurers look at both the PPOR AND the IP Loan, work out a LVR based on the value of the underlying security - and then impose Mortgage Insurance accordingly.
Substance over form is alive and kicking - and the ATO love it. I work in tax structured finance which seeks to capture tax arbitrage or tax advantages in transactions such as cross border leases, securitisation, tax sparing, tax effective derivative and foreign tax credit utilisation structures. I have also worked on tier 1 deals which currently is a hot issue on the ATO books (known in Australia as "Income Securities"). In all our deals, enormous work is spent setting up the right legal form of the transaction to create the desired tax outcome. But increasingly the key concern of the ATO and other revenue offices in Europe, Asia and the US.... is whether the substance of the transaction gives proper and commercial effect to the legal form (read the current Income securities rulings and you will see this vigilance at work). It is against this background that I raised the risk in the original post - perhaps i have become a tax party pooper as a result !
As for your refund LMI point - i am aware of 2 investors who got a full refund. I know others who got more than a 40%. Admittedly, these cases were last year, and if the policy of ALL the Mortgage Insurers have now moved to an inflexible, can-only-do-40%-refund, then i am happy to defer to your experience, given that you are in the broking industry. I am aware of the ANZ bulletin that was circulated in august to the brokers which explained the 40% refund cap... but have all banks moved to this position...and is it set in stone. No idea.
Richard, you do not need to convince me of your structure. It is the ATO that ultimately needs to be satisfied of your argument. Like most people on this forum no doubt, I have enjoyed your posts so far. I have worked with good tax advisers and lawyers and it seems that you have been in the game for a while -which is fantastic for the forum.
For someone who has never paid LMI and does not have a vested interest in the outcome of this post- i feel i have said w a y too much !
Cheers
Waverly