Investment loan interest payments and part IVA

Earlier this year the ATO released Taxation Determination 2012/1 (which finalised a previous draft determination TD 2011/D8) which states Part IVA of the Income Tax Assessment Act 1936 can apply to deny a deduction for some, or all, of the interest expense incurred in respect of a specific mortgage reduction scheme.

In general terms, these schemes are structured such that income is directed to the taxpayers home loan while expenses, including tax payments, are paid from a separate investment loan or line of credit.

These arrangements generally  involve medical professionals generating patient fees which are applied to quickly reduce the professional’s non-deductible home loan, whilst, in the meantime, generating a purportedly deductible debt.

The Determination confirms that the Part IVA anti-avoidance provisions can apply to an investment loan interest payment arrangement despite a taxpayer’s stated intention of ‘paying their home loan off sooner’ or ‘owning their own home sooner’.

Typically, these arrangements take the following form:

  • The taxpayer has two (or three) loans or lines of credit.
  • One of these will relate to the purchase of the taxpayer’s main residence (“the home loan”).
  • The other loans or lines of credit will relate to deductible items (such as running costs for a medical practice or the purchase of an investment property) (“the deductible loan”)
  • The arrangements result in the majority of the taxpayer’s gross income derived from the medical practice or investment property being directed towards the home loan.
  • Deductible expenses relating to the business or investment property are capitalised to the deductible loans.  This has the effect of reducing the home loan much faster than usual, whilst the deductible loan increases substantially.  Interest on the deductible loan may or may not be capitalised to the deductible loan during this time.
  • The borrowing limits relating to the deductible and home loans may be renegotiated over time, as required (typically the deductible loan limits will be increased as the home loan balance is reduced).
  • Once the non deductible loan is repaid, it is purported that the taxpayer will have a substantial loan on which the interest is wholly deductible.

Where anti avoidance provisions are found to apply, the tax office would seek to reverse any tax benefits received by the taxpayer, and may also apply significant penalties and interest.

It should be noted that a Tax Determination is not law however it does outline the ATO’s position and interpretation of the law.  The ATO have also recently stated as part of their annual compliance program that they will be looking at structures specifically used by medical practitioners.

Whilst the anti-avoidance provisions may apply differently to different arrangements, in light of this Tax Determination we strongly recommend reviewing your personal circumstances where you have entered, or have considered entering, into arrangements such as these.

Should you wish to discuss any aspects of the above arrangements please contact your local William Buck advisor.