Brokers dealing with investment loans could unwittingly risk being prosecuted by the ATO as ‘scheme promoters’, says a legal expert.
Mark Halsey, principal of Halsey Legal Services, recently represented a financial advice firm that was targeted by the ATO in relation to the type of arrangement described in Tax Determination 2012/1.
This kind of arrangement is determined by the ATO to be a breach of Part IVA of the Income Tax Assessment Act 1936
- but Halsey says many brokers are advising clients to undertake these kinds of arrangements without realising they could be breaking the law.
“I think it’s a real problem and it’s a communication problem - it’s one of those things that slipped in under the radar and it has the potential to have really catastrophic impacts on both the clients and the brokers,” says Halsey.
Borrowers that enter into these kinds of arrangements are generally investors with a home loan on their principal residence, an investment loan and a line of credit that funds interest on the investment loan.
The line of credit is drawn down to pay the interest on the investment loan, but because the line of credit can be claimed as a tax deduction it is allowed to capitalise and compound while all of the client’s available cash is used to pay the debt on their home loan.
The result is a shorter amount of time to repay the loans and less money paid in interest.
Halsey believes a number of brokers are advising of these types of arrangements with the belief that they are operating in their client’s best interests, without realising that it is a breach of Part IVA.
“I think a lot of people are unaware. I think it’s unfortunate that when the tax determination came out it was during the Christmas break… a number of people I’ve spoken to doing similar sort of things just didn’t know. People are inadvertently breaking the law.”
Borrowers who enter into these kinds of arrangements are said by the ATO to be involved in a ‘scheme’, says Hasley, and brokers who advise of these schemes are labelled as ‘scheme promoters’.
Regardless of whether the intention of the arrangement was simply for the client to pay off their home loan sooner, these schemes are regarded as Part IVA tax avoidance, according to Tax Determination 2012/1.
“It’s a double-pronged effect here. Firstly you’re black-listed by the authorities and undoubtedly pursued and fined for being a scheme promoter, but you’ve also got very, very unhappy clients coming after you.
“It’s a slam dunk because clients are going to want compensation for this – they’ve been put in a situation that caused them to be prosecuted.”
In many cases the brokers learn the technique from colleagues, says Hasley, without realising it could create problems with the Tax Office.
“I wouldn’t say it’s the normal approach, but there’s enough out there that it’s a concern and if its drawn to more adviser and brokers attention then that will certainly help.”
The ATO keen to raise awareness of the issue, says Hasley.
“From the regulator’s point of view they’re saying ‘What more can we do? We’ve published it as a public determination; we’ve got it on our website’.”
Brokers who believe they may have fallen foul of Tax Determination 2012/1 are encouraged by the ATO to come forward. While Hasley stresses that each case will be "reveiwed on its own merits", with legal advice brokers who were genuinely unaware of the illegality of their actions may be spared prosecution.