Split or Linked Loans - Tax Consequences

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Background to Split Loans

In the late 1990’s some financial organisations began marketing “split” or linked loans on the basis of their potential tax advantages. The loan was structure into to two “split” sub accounts: one for investment use and one for private use. The loan repayment amount was calculated on the total borrowings. However, repayments were allocated firstly to the private account. Total interest was calculated on the closing balance in each sub-account and allocated to the respective accounts. Consequently, the balance of the private sub-account reduced with each payment while the balance of the investment sub-account continued to compound with the capitalisation of interest as it remained unpaid. The tax effect was to counter the “purpose” test by converting private debt to investment debt.

ATO's Responses

Naturally the Tax Office was not happy with the split loan concept and issued Taxation Ruling TR 98/22: Income tax: the taxation consequences for taxpayers entering into certain linked or split loan facilities. 

The Tax Office view was that the extra interest that accrued in the investment sub-account was “not deductible…and that Part IVA of the Income Tax Assessment Act 1936 (the anti-avoidance provisions) applies to split loan arrangements.”

Case Law

The law was tested in Hart’s case where the court was told that the couple's $298,000 loan taken out in 1996 would have generated $169,470 in increased income tax deductions as a result of their split loan. It meant their home was paid off faster, but it blew out what was owed on the loan on the investment property from $120,592 to $233,085.

The Tax Office lost the first round but in the May 2004, the High Court upheld the Tax Office view.
This is not to say that “split loans” will attract tax office attention. It simply means that split loan facility repayments must be apportioned between the sub-accounts. 

In fact, accountants prefer split loan facilities as they clearly distinguish between investment and private accounts and associated interest. Where a line of credit facility is used, a split loan can also isolate extra repayments and redraws that tend to occur within these loan structures. 

Example - each sub-account can be setup with either interest only, principle and interest or line of credit. Where the investment sub-account is setup as interest only and repayments of the interest are made, what occurs in the private sub-account, whether extra repayments or additional redraws, will not affect tax deductability of interest in the investment sub-account.

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