Parking borrowed money in an offset account
I Thought I would start some tax tips so I don’t have to keep repeat typing the same thing over and over again.
Many people borrow money and deposit that borrowed money into a savings account or an offset account and then later use that money to invest. In these cases, will the interest be deductible?
The answer is “Maybe”!
In relation to investing, under s8-1 ITAA97 an expense is deductible if it is incurred in gaining or producing assessable income. Interest is generally deductible under this section. But problems can arise where the ‘incurring’ is not directly connected with the investing.
In a legal case from 2004 Mrs Domjan borrowed money, and moved it, briefly, from the loan account into a savings account to write a cheque. The savings account contained other money which was not borrowed. So when she wrote the cheque to purchase an item for her investment property it could not be said that Mrs Domjan had used the borrowed money – it could have been the cash in the account.
The connection between the borrowing and investing was broken by the borrowed money taking a detour before investing.
Some have argued that where the savings account is empty then there will be no co-mingling of borrowed and non-borrowed funds if the loan is drawn down into this account. This is true, but where interest is incurred on the borrowed funds it cannot be deducted as there is no income generated. However, where the savings account is an offset account there is no interest incurred at all as the borrowed money is in the offset offsetting the loan. If this borrowed money is later used for investment, then the interest will start to be charged on the loan. My opinion is that this interest can be traced to the investing and the interest should be deductible (assuming no mixing).
However as far as I know there is no legal or ATO authority to say this is correct, except for one private ruling that I have found – see Private Ruling Authorisation Number 57920.
Question 1 of this ruling is the relevant question here. Note that the circumstances to this question differ from our scenario of ‘topping up a loan’ as this situation involves the taxpayer borrowing extra at the purchase, similar but slightly different, to a person accessing equity by further borrowings.
This private ruling cannot be relied upon by anyone other than the person who applied for it – within the dates listed.
So, in summary
- Borrowing money to park in a savings account will probably result in the interest being NOT deductible.
- Borrowing to park in an offset account may result in the interest being NOT deductible where the offset contains other non-borrowed money. The interest could possibly be deductible in part.
- Borrowing to park in an offset account may result in the interest PROBABLY being deductible when the offset funds are used to invest at a later date.
Where an offset account is involved it is very easy to get mixed up or confused with account numbers etc. and to inadvertently deposit non-borrowed money into the account. This is harder to do with a loan account and the effect is less as any deposit can be left there without contaminating the loan. Where borrowed money is in the offset and non-borrowed money is deposited into that account it will be impossible to rectify. It would be like putting a drop of urine into a cup of tea – you can’t take the urine out again. If you think you can, would you drink the tea?
To avoid the risks of ruining deductibility I suggest a better way to proceed would be to use an Interest Only loan where you can draw down the funds at settlement and put them straight back into the loan. The funds can sit there until needed and then be re-borrowed from the loan at the time of investing. Or the funds can stay in the offset, and then go back into the loan a few days before re-borrowing again to invest.
Alternatively use a LOC product. These allow a credit limit with funds capable of being drawn (i.e. borrowed) when needed. The disadvantage with LOCs is the higher interest rate and the fact that these loans are often (but not always) without a fixed term and can be called in by the lender at short notice. However, once the money is actually used the LOC could also be converted to a term IO loan. This way you get the best of both worlds.
And keep in mind:
Even depositing rent in an offset containing nothing but borrowed money will contaminate the loan. If the offset contains the borrowed money only you can trace it back to the borrowings, so the interest will PROBABLY be deductible (see tax tip 1). But as soon as you mix non-borrowed money in an offset containing only borrowed money it will be contaminated and AT BEST you will have to apportion the interest. Doesn’t matter what the source of the money is.
- Domjan v Commissioner of Taxation  AATA 815 http://www.austlii.edu.au/au/cases/cth/AATA/2004/815.html
- PBR Authorisation Number 57920
Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au