Summary of issues raised and responses
No LOC, investment loan has an upper limit of $100k over the drawn amount. Would the situation be different if the taxpayer directed their rental income to his non deductible debt and the investment interest compounded? 2. Same as 1 but taxpayer does not have a non deductible loan and simply chooses to spend the rent on lifestyle. What gives the ATO the power to direct taxable income (rent) toward a loan payment if the taxpayer chooses to spend it instead? How would this affect the deductibility of the loan? 3. If the rent is directed toward the private expenditure due to financial difficulty and the interest on the investment loan is compounding the dominant purpose is not to obtain a tax benefit. 4. If I had a business I may choose to meet the interest payments on an investment loan from my overdraft whilst banking the cash in an interest bearing account. This could potentially affect thousands of business. 5. In many cases taxpayers want to pay off their private home as quickly as possible. The investment property is not as important as little or no emotion is involved. As is the case with many investment properties the rent is not sufficient to cover the interest payments. How will the ATO view a situation where the rent is $1,000 and the interest is $1,500 per month? The shortfall of $500 is paid from a LOC. The taxpayer simply cannot afford to make up the shortfall.
Compendium
The ATO published responses to 20 submissions on this ruling in TD 2012/1EC. Outcome labels are heuristic — read the ATO response for the detail.
1Inadequate consideration of the 'ordinary' provisions There has not been adequate consideration of how the 'ordinary' provisions could apply to these types of arrangements based on existing case law. The ATO appears to have 'missed a step' by going straight to Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936). [2] The principles from the decisions in Roberts and Smith [3] (regarding business assets) and Jones [4] and Brown [5] (regarding business losses) could be logically adapted for non-business assets such as rental properties in a manner that could resolve the current concerns about 'excessive' capitalised interest, without resorting to Part IVA. Consideration should be given to adopting a more objective approach.partial
ATO response
The Commissioner agrees that the 'ordinary' provisions are first considered and could apply to deny the deduction for the interest on the line of credit in part or in full in some factual situations. We see no compelling reason to discuss the application of the ordinary provisions in a Determination that is considering the application of the general anti-avoidance provision (Part IVA) to an investment loan interest payment arrangement of the type described in the Determination. To ensure it is clear, the Ruling section has been modified to include the qualification that the interest is otherwise an allowable deduction (refer to paragraph 1 of the Determination).
2. Lack of clear guidance The draft Determination is confusing as the Ruling section of the draft Determination simply concludes that taxpayer's purpose of 'paying off their home loan sooner' does not preclude the application of Part IVA to the loan arrangements, however in contrast the supporting 'Explanation' positively asserts that the arrangements it describes should attract the operation of Part IVA. The draft Determination should be limited to answering the question posed or expanded substantially to provide better clarity around what particular arrangements or features will cause the ATO to apply Part IVA and why. The breadth of the statement in paragraph 19 of the draft Determination may be interpreted as indicating that the Commissioner's view is that all arrangements resembling the investment loan interest payment arrangements, as described in the draft Determination, are schemes to which Part IVA applies. In the absence of features that are explicable only by their taxation consequences, such investment loan arrangements lack the requisite dominant purpose of obtaining a tax benefit that attracts Part IVA. Accordingly, the draft Determination needs to more clearly express the Commissioner's position. The draft Determination does little to clarify the law or provide certainty about the law. By indicating that Part IVA may apply without giving any clear guidance about the circumstances in which it will apply, increases uncertainty. The arrangement as described in the draft Determination is a typical arrangement for many taxpayers with a mortgage, whether they have a rental property or not. The issue appears to be one of what is reasonable for the taxpayer to pay off the rental property line of credit (LOC) when no repayment is actually required. The statement that they should meet the interest payments from their other cash flows is counter to case law and the principle that it is not for the ATO to tell taxpayers how to manage their money. If the ATO is going to continue to not respond to private ruling requests and issue retrospective rulings, then this ruling needs to provide far more detail and consider many more cash flow situations. (Please do not respond with 'each case turns on its own set of facts' because taxpayers have to operate under self assessment and the ATO's history of answering private ruling requests on the topic is that no one will get an answer). If the ATO proposes to rule that a strategy to pay your home loan off sooner can be caught under Part IVA, then you need to give taxpayers strict guidelines on just how and when and on what they can spend their money. Anything less will create uncertainty in a self assessment regime