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ATO slams 'most common' investment strategy as illegal

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Australian Broker | 06 Dec 2013, 08:10 AM Agree 0
The ‘most common’ investment strategy recommended by brokers and advisers has been slammed by the ATO as bad practice and a breach of tax law.
  • grahame hale | 06 Dec 2013, 10:01 AM Agree 0
    Why are investors going to such lengths to set up these schemes. There are plenty of legal option or arrangements. Advisors or accountants who set them up know what the primary reason is and that is to avoid or minimize tax. The advisors and accountants are getting a fat fee as a result and the liability falls on the investor.
  • Country Broker | 06 Dec 2013, 10:04 AM Agree 0
    Ho Hum They have been alerting us for a number of years on this , as finance brokers I stress that I do not give tax advice and the clients must seek all such advice from their accountant , Mortgage brokers need to keep very clear file notes on what was discussed and when. The trouble to me is when you have a financial adviser who is also a mortgage broker and they may be affiliated or owned by an accounting firm , it would need to be very clear who was giving what advice. Best thing for us is to avoid the structure of these loans.
  • Rodger | 06 Dec 2013, 10:06 AM Agree 0
    Are their any implications for clients who deposit all their income, rental etc. into offset accounts to minimise loan balances and tax liabilities
  • Brisbane Broker | 06 Dec 2013, 10:08 AM Agree 0
    I can't believe people are still doing this. The ATO cracked down in it many years ago. Us older more experienced brokers understand this. It seems the people newer to the industry - and involved with investment property marketers - are the ones caught up.
    As for the "snowballing" explanation. You say that the rent is coming in but the loc is compounding but the client is not paying the shortfall. Well who is ?? I'll bet you're capping the interest on the increased amount and telling the clients they can deduct all of it...ATO now looking at us again because of dodgy spruikers..
  • Inner East Melbourne Broker | 06 Dec 2013, 10:10 AM Agree 0
    Im pretty sure that 'snowballing' is NOT a common industry practice - anyone who has been in broking or banking in the last 10 years are bound to have heard of the Hart case!

    I would say this was a pretty misguided comment from a broker obviously not on top of his game.
  • Kram | 06 Dec 2013, 10:11 AM Agree 0
    We seem to get a lot of "Eastern States" clients coming over to WA, with this situation where they were advised to capitalise their investment property interest in their LOC/s. It's often resulted in clients having greater than 100% debt on the security value (and thinking it's good), with no way to move (financially) if needed. Tax deductions are one thing, going backwards in your debts is just not necessary. (NOTE : All financial situations are individual and this comment is based on the idea that you can have tax effective investments, whilst claiming deductions and paying off the asset... and paying taxes that are required).
  • John | 06 Dec 2013, 10:20 AM Agree 0
    Of course Brokers should refer to Accountants for specific Tax Advice, but clients expect some level of GENERAL advice on loan structuring. Why doesnt the MFAA -FBAA take a stand on WHAT GENERAL ADVICE can be given? Eg Ok to captialise Inv property insurance, management fees, rates etc NOT OK to capitalise INTEREST, BUT check with Accountant for your particular tax circumstances. Unfortunately, they usually just play it too save & say "give NO general advice" because they're not working Brokers.
  • Peter Fast | 06 Dec 2013, 10:34 AM Agree 0
    Hart's case is well known but after 10 years as a broker I have never heard of "snowballing" - until now. I must be under a rock of some sort. Same scam different name so only time before the ATO cans this one so look out the spruikers.
    Also don't include me as one of those who use this and if it is used so widely promoted by brokers (your words) why haven't the MFAA and FBAA sought to have it banned. Afterall they are there to uphold standards.
  • Dave Robinson | 06 Dec 2013, 10:44 AM Agree 0
    Funny how the longer term brokers (10 years or more) know all about this and stay away. If the new recruits are doing it then is this a shortfall in the training/NCCP Act or is it something else.

    Looking forward to the MFAA/FBAA (yep member of both) highlighting this illegal practise which (according to some) is "most common" among our industry.
  • Thomas | 06 Dec 2013, 10:50 AM Agree 0
    I cant believe we are still talking about this following the Hart case. It doesn't matter what guise it falls under; snowball, hairball, furball. The ATO are pretty clear in the Hart case that interest charged on interest is not a legitimate deductible expense. It's black and white. If you want to capitalise interest - that's fine. But you can only claim the portion of interest attributable to the initial (uncapitalised) debt.
  • John | 06 Dec 2013, 10:51 AM Agree 0
    Does interest capitalisation rules apply to overdraft and credit card also for investment/business use?
  • Sydney Broker | 06 Dec 2013, 10:59 AM Agree 0
    To Roger at 10.06 am.
    Offset accounts are a perfectly legal and preferred vehicle as the Loan Balance its self does not change or diminish (unless P & I)
    I cannot believe this conduct and very poor advice re the structuring is still going on well after the Hart case. The difficulty as I see it, is that in today's marketplace we now have to position ourselves as more than just a facilitator of loan applications. If you are experienced, then your clients expect you to give them guidance re the correct structuring of a loan, whether it be a straight forward OO matter or a more sophisticated investment option. If you refer it to the clients accountant for financial advice re the structuring they often only give the clients advice re the Tax implications and no advice re the structurig of the loan itself and the clietn refers back to you re the loan strcuturing as you are the expert in morgages. You also run the risk of the accountant referring your client to one of his cronies or the accountant themselves dables in mortgages now and then. We are fast becoming postioned between a rock and a very hard place!
    To John at 10.20am I could not agree more!!
  • Joe Broker | 06 Dec 2013, 11:06 AM Agree 0
    Why not just service interest payments as and when they fall due?
    MFAA/FBAA: do you think you could try telling the banks to ask that of their borrowers?
    Can't be that complicated.
  • Brisbane Broker | 06 Dec 2013, 11:15 AM Agree 0
    Memo to the new brokers and spruikers still doing this..
    Steve Hart went to prison.......
  • Ken Crawford | 06 Dec 2013, 11:21 AM Agree 0
    I suspect it is common in Financial Planning circles and therefore washes over to mortgages when the investment strategies are set up. The rules are clear but the planners are the ones who promote these schemes it seems. I carry the decision with me to alert borrowers and will not arrange finance in this way.
  • Denise Brailey BFCSA (Inc) | 06 Dec 2013, 11:32 AM Agree 0
    BFCSA agrees: “We encourage taxpayers and advisors who may be concerned that they have entered into arrangements of this type to lodge a ruling request with the ATO.”
    We reported all this in 2005. Brokers have been set up. Time for advisers to protect themselves.

  • Mike | 06 Dec 2013, 11:48 AM Agree 0
    As a financial adviser and a broker I think the issue remains the 'Dominant Purpose'.

    Brokers need to demonstrate that the finance is for investment purposes just as much as the client to ensure any LOC is being used wholly for investment purposes.

    If you are legitimately acquiring an asset for investment purposes surely as interest rates rise and fall there may be positive and negative cashflow impacts which an LOC can assist with.

    If all income is being attributed to the investment LOC and the cashflow from the investment is negative for a given year or years, this needs to be considered.

    Here in lies the issue in my opinion. Not many planners consider the pre and post tax cashflow from an investment property to ensure the level of debt and cost is both practical and responsible.

    Advisers have a legislated duty of care to their clients and it's in their clients best interest to manage and review their cashflows to ensure debts are appropriate.

    Equally brokers can ask a few questions to unpack how a client plans to use the LOC facility? what outstanding balance does the client expect to have in 2 years on the LOC?

    Tax fact sheets (prepared by another firm?) can educate clients about the importance of using investment debt for reasonable reasons.
  • Papery | 06 Dec 2013, 11:49 AM Agree 0
    Aside from the ATO position, Ive seen a number of clients come unstuck with these capitilised interest schemes (I detest them!).....& usually the borrower has only modest PAYG income to start with & who have been sold by the Spruikers & their clever Broker cronies. You know....Property values always rise & rents always go up.....let the taxman & the tenant pay for your future wealth & retirement!

    At some point the borrower hits the ceiling of the LOC & HAS to start fully servicing the debt/interest...or sell....& usually after they discover they cant refinance (which is what the Spruiker said they could do) to create more 'space' on the LOC; usually due to inability to demonstrate a servicing position &/or diminished valuations.
  • Patrick | 06 Dec 2013, 01:16 PM Agree 0
    In Hart the High Court did not rule that deductible interest capitalised and additional interest on interest thereby incurred was not deductible (see TD2008/27). The Court held that the Wealth Optimiser product contrived a deduction for capitalised interest which was a scheme captured by Part IVA. The key fact was that a single fully amortising loan divided into portions each with contrived different repayment terms was artificial. The Court also stated "where a taxpayer used two separate loans, each having different terms and conditions, this should normally be acceptable". The ATO won a battle but not the war and has since engaged in a duplicitous campaign to minimise taxpayer use of a strategy confirmed as legal by the High Court. If I choose a separate interest only loan for investment along with a principal and interest loan for a home and the investment was (or became through income growth) positively geared but I applied the surplus cash flow to accelerate repayment of the home loan or meet other private expenses and kept the investment loan interest only the ATO would be unlikely to be so bold as to label this "an investment loan interest payment arrangement" as it is a widespread and accepted practice. If however I am negatively geared or for other reasons choose to fund investment interest with further borrowings the ATO seeks to twist the law to deny me a legitimate deduction for the interest upon interest thereby incurred. We need a further test case to control the inappropriate zeal of the ATO.
  • Accountant | 06 Dec 2013, 04:43 PM Agree 0
    You shouldn't be bashing advisers and accountants here. Most of you are mistaken, the Hart Case involved P & I loans - not LOC's. Capitalisation of interest on interest on a LOC was only outlawed in the last few years by the ATO.
  • Marty | 07 Dec 2013, 11:00 AM Agree 0
    I disagree I think snowballing is legit as over time if the rent to interest shortfall is small it will in time reverse and the loc balance will decrease as the investment becomes positive.

    What about a margin loan? Are you saying someone geared at 50% and reinvesting all dividends back to the loan is in a scheme too? No didn't think so.

    Your / I am not an accountant and this is a very grey area which is totally different to Harts case. Seek advice.
  • Perth broker | 09 Dec 2013, 03:26 PM Agree 0
    Can someone tell me whether or not this is ok please: if a client has a LOC and deposits all the rent into here each month (and hence "pay" the interest charge on the LOC), make the I/O repayments to the main investment loan each month (instead of using their own money), but do not claim any of the interest charged on the LOC each month as a deduction (only the interest on main loan), does this fall under this Ruling? They are only claiming the I/O repayment each month on the investment loan for the property which is allowable, but no interest from the LOC, so there is no double dipping or is this not acceptable? Thanks.
  • John Smith | 27 Mar 2014, 10:04 AM Agree 0
    I think you may be all missing the point - how are they set up like this anyway ?? I mean where did the extra equity come from. Its doubtful they put in extra cash so they could do this. - you see snowballing only works if there is equity within the investment property (IP), and its a good bet that the equity is from capital growth. Before that capital growth they would have used the rent and personal money to make the payments, and now after capital growth they get a new LOC loan for a greater value against the IP, and use that to capitalise the interest. To me that would definitely be tax avoidance under 4a, as there is no purpose other than to avoid tax.
  • Marty | 27 Mar 2014, 10:20 AM Agree 0
    @John smith. The loc is usually set up against another property from the outset not the IP itself. Usually the borrowers home.
  • Patrick | 27 Mar 2014, 01:41 PM Agree 0
    Further to my comment on 6/12/13, I note Accountant on the same date stated "Capitalisation of interest on interest on a LOC was only outlawed in the last few years by the ATO." The ATO cannot overrule a decision of the High Court by simply publishing a ruling. They must either submit a proposal through Treasury to get specific legislation passed (for example Keating's Native Title Act to overturn the Mabo Case) or they must promote a further test case through to the High Court and hope to achieve a different outcome or at least a distinction based upon a difference in the relevant facts. The ATO is purposefully misinterpreting Hart and illegally attacking properly structured uses of capitalised interest with a view to curtailing what they subjectively and incorrectly believe is unacceptable leakage of revenue. Imagine if the ATO attempted to do this more widely, for example, issue a ruling stating that borrowing more than an amount which can be fully serviced by the relevant investment income to create a negative gearing tax benefit is a scheme. Given the extensive case law confirming negative gearing as legitimate they would be quickly challenged and forced to back down. They are however doing just this in relation to the High Court decision in Hart. In Hart the taxpayer lost not because they capitalised interest, but because the loan product was defective and artificially capitalised interest on one portion of the loan while applying all repayments to another portion. The capitalised interest claimed as a deduction was in the words of the High Court "contrived by the particular form of the borrowing" and was an "artificial feature of the arrangements". It was critical to the outcome that there was only ever one loan, albeit divided into portions. The Court clearly stated "where a taxpayer used two separate loans each having different terms and conditions" this would be a different matter entirely.
  • Dylan Agaundo | 31 Jul 2015, 03:19 PM Agree 0
    I agree with the citizens of the australians whom avoid or minimize tax because the some advisors and accountants are getting a fat fee as a result.but in our Firms Tax Depreciation Schedule Melbourne the service under the best Quantity Surveyor for the Investment Property Depreciation Schedule,Rental Property Depreciation Ato,House Depreciation.
  • Harold Spencer | 03 Aug 2015, 01:30 PM Agree 0
    My understanding is that the ATO has been looking into these types of structure since 1995/6 and the bottom line is they don't like them. So I think the question to ask is: "If the ATO audits my client after I suggest this structure will I sit next them during the audit? "

    If you can't/won't then I think you have answered the relevant question and if you can/will then expect each and every client to go through the audit. Your choice, your life, your business.
  • Dylan Agaundo | 11 Aug 2015, 09:09 PM Agree 0
    ATO slams 'most common' investment strategy as illegal why ? because its process always in the right way but some firm of tax depriciations are use the illegal way so that way Quantity Surveyor not ready to Create the tax depriciation report.
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