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Tips for last minute tax planning |
With the end of the financial year galloping towards us, a few recent changes in the tax area are worthy of note. They may have implications for people doing a bit of last minute tax planning.
The Tax Office as usual is keen to secure the Federal Government’s revenue base and to prevent any rorting of the system. As part of this it has been to court on a number of occasions recently. When it has not been happy with the outcome it has gone higher up the chain to higher courts or, when that fails, to the Government seeking legislative changes.
Split loans
Back in July last year the Tax Commissioner lost his argument before the Full Court of the Australian Federal Court in relation to split loans. These loans are basically about capitalising interest on an investment loan and claiming the entire interest component as a deduction.
Over the last few years they were all the rage until the Australian Tax Office (ATO) disallowed them.
Typically under these arrangements an investor has a normal home loan and an investment loan, usually packaged together in some way. Some promoters specifically set up the arrangement but it is possible to do it yourself with even a simple home equity loan.
The idea is to repay the home loan, where the interest is not deductible, as fast as possible. You do this by directing all repayments, including say rent from an investment property, to the home loan and ignoring the investment loan where the interest is capitalised.
This interest, including the interest on the interest, is claimed as a deduction.
Following a challenge to the ATO’s ruling, the court found that the arrangement was not a tax avoidance measure and that therefore Part IVA of the Tax Act did not apply. The ATO however is appealing to the High Court so the matter remains uncertain.
If the High Court also rules against the Tax Commissioner than according to some analysts, split loans and similar arrangements will become even more popular – perhaps causing a significant dent in the Federal Government’s revenue. For this reason the ATO may seek legislative changes if it loses.
Protected loans
The Tax Commissioner also lost this one in court but once again legislative changes are expected.
Capital protected loans protect investors against any fall in the value of their investment. Typically the loans are taken out to buy shares.
The price for this protection is a high interest rate – sometimes in excess of 20 per cent. The institution providing the loan uses the extra interest income to buy the protection on the derivatives markets.
The Taxation Commissioner ruled against the product insofar as only a benchmark interest rate, such as a rate that applied to ordinary loans, could be allowed as a deduction.
The excess was regarded as part of the capital purchase price and hence not deductible against income.
However the Federal Court recently ruled against the Commissioner and allowed full interest deductibility. Once again the Tax Commissioner has taken it further.
The latest Federal Budget papers reveal that the Federal Government is expected to realise an extra $27 million in revenue over three years from changes to the way these products are taxed.
No legislation at present exists to allow this to happen so it leaves investors with some uncertainty.
Aggressive tax planning
The Tax Office has once again signalled that it will attack aggressive tax planning schemes and tax shelters.
Many small investors have been enticed into these schemes in the past; agricultural schemes were a particular favourite. The Tax Commissioner regards many of these schemes as rort. He does have a case.
In some circumstances very high income earners have been able to reduce their taxable income to virtually nothing.
Suspect schemes
Some of the characteristics of a scheme that the ATO finds suspect are: it involves a tax haven; the arrangements are contrived or artificial, there is no risk to the investor; there is no real underlying business activity; and there is limited or non-recourse financing or round robin financing. The degree to which the tax deduction makes the venture viable is also a key factor.
In the past, where the Tax Commissioner has ruled against these schemes, investors have had to repay tax going back years. It is much better to make sure that the ATO has given the scheme its tick of approval before you go into the scheme.
The ATO issues product rulings – but there is a caveat. The scheme as implemented has to be the same as that approved by the ATO. Any changes could make it suspect.
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