Income tax: tax consequences for a borrower under a mortgage reduction program managed by Allstate Home Loans

This Product Ruling sets out the Commissioner's opinion on the way in which the relevant provisions identified in the Ruling section apply to the defined class of entities who take part in the scheme to which this Ruling relates. All legislative references in this Ruling are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise indicated.

In this Product Ruling the scheme involves the refinancing of a borrower's home loan and investment loan, each managed by Allstate Home Loans Pty Ltd (ASHL), and entry by the borrower into a monitored service designed to assist them to accelerate the repayment of their refinanced home loan.

This Product Ruling does not: • address the deductibility of interest incurred by the borrower under the investment loan pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997); [1] • address the treatment of any costs, fees and expenses (including borrowing expenses) payable by the borrower under the scheme; • apply to the original or refinanced home loan of the borrower, or to any offset account linked to the borrower's refinanced home loan; • address the borrower's tax obligations and benefits in relation to the acquisition, holding and sale of a property or any other asset acquired with either the home loan or investment loan; and • address whether the scheme constitutes a financial arrangement for the purposes of Division 230 of the ITAA 1997 (Taxation of financial arrangements).

This part of the Product Ruling specifies which entities can rely on the Ruling section of this Product Ruling and which entities cannot rely on the Ruling section. In this Product Ruling, those entities that can rely on the Ruling section are referred to as the borrower.

The class of entities who can rely on the Ruling section of this Product Ruling consists of those entities that enter into the scheme described in paragraphs 16 to 20 of this Product Ruling on or after the date this Ruling is made and on or before 30 June 2016.

The class of entities who can rely on the Ruling section of this Product Ruling does not include entities who enter into this scheme before the date of this Ruling or after 30 June 2016.

This Product Ruling does not address the provisions of the Superannuation Industry (Supervision) Act 1993 (SISA). The Commissioner gives no assurance that the scheme is an appropriate investment for a superannuation fund. The trustees of superannuation funds are advised that no consideration has been given in this Product Ruling as to whether investment in this scheme may contravene the provisions of SISA.

The class of entities defined in this Product Ruling may rely on its contents provided the scheme actually carried out is carried out in accordance with the scheme described in paragraphs 16 to 20 of this Ruling.

If the scheme actually carried out is materially different from the scheme that is described in this Product Ruling, then: • this Product Ruling has no binding effect on the Commissioner because the scheme entered into is not the scheme on which the Commissioner has ruled; and • this Product Ruling may be withdrawn or modified.

This Product Ruling applies prospectively from 4 December 2013, the date it is published. It therefore applies only to the specified class of entities that enter into the scheme from 4 December 2013 until 30 June 2016, being its period of application. This Product Ruling will continue to apply to those entities even after its period of application has ended for the scheme entered into during the period of application.

However the Product Ruling only applies to the extent that there is no change in the scheme or in the entity's involvement in the scheme.

Although this Product Ruling deals with the income tax laws enacted at the time it was issued, later amendments may impact on this Product Ruling. Any such changes will take precedence over the application of this Product Ruling and, to that extent, this Product Ruling will have no effect.

Entities who are considering participating in the scheme are advised to confirm with their taxation adviser that changes in the law have not affected this Product Ruling since it was issued.

Product Rulings were introduced for the purpose of providing certainty about tax consequences for entities in schemes such as this. In keeping with that intention the Commissioner suggests that promoters and advisers ensure that participants are fully informed of any legislative changes after the Product Ruling has issued.

The application of Part IVA of the ITAA 1936 depends on a careful weighing of all the relevant facts and circumstances of each case. Provided the scheme ruled on is entered into and carried out as described in this Product Ruling, the anti-avoidance provisions in Part IVA of the ITAA 1936 will not apply to deny the borrower of a deduction allowed under section 8-1 of the ITAA 1997 for interest incurred under an investment loan refinanced as part of the scheme.

The scheme that is the subject of this Ruling is identified and described in the application for a Product Ruling as constituted by documents and information received on 11 July 2013, 20 August 2013 and 26 August 2013.

For the purposes of describing the scheme to which this Ruling applies, there are no other agreements, whether formal or informal, and whether or not legally enforceable, which the borrower, or any associate of the borrower, will be a party to, which are a part of the scheme.

All Australian Securities and Investments Commission (ASIC) requirements are, or will be, complied with for the term of the agreements.

Following is a summary of the scheme: (a) As part of its business as a mortgage manager, ASHL offers borrowers with both a home loan in respect of a residential property that is their main residence, and an investment loan used to fund an asset acquired by the borrower for the purposes of producing assessable income, the opportunity to participate in a scheme involving the refinancing of both those loans, the primary purpose of which is to repay the refinanced home loan at an accelerated rate. (b) The asset acquired with the investment loan may be a residential property other than the borrower's main residence, or any other asset other than for business use. The borrower holds legal title to that asset, as well as their main residence. (c) The application to refinance both the home loan and investment loan is completed and lodged by the borrower (via an accredited finance broker) with ASHL. (d) ASHL assesses the loan application in accordance with standard lending criteria which may, where necessary, include the undertaking of a valuation of the security by a licensed valuer, before sending the application off to a wholesale lender (referred to as Funders for the purposes of this Product Ruling) with whom ASHL is a mortgage originator partner for their assessment and approval. (e) Whilst ASHL is responsible for the ongoing management of the refinanced loans, the credit to fund the refinance of the borrower's loans will be made available by one or two Funders. The refinanced loans may or may not be funded by the same Funder. Therefore, upon approval of the borrower's application by the Funder(s), and the subsequent execution and return of new loan contracts by the borrower, the existing loans will be settled and replaced by new loans funded by the Funder(s). (f) Some of the key features of the refinanced home loan are: • a maximum term of 30 years; • a minimum loan amount of $150,000 and a maximum loan limit of $1,000,000; • periodic instalments by direct debit of either interest only or principal and interest; • interest accruing daily at either a variable rate (generally a discount variable rate) or a fixed rate, within accepted industry margins; • the provision of the loan on a full recourse basis; and • the holding of a registered mortgage by the Funder over the property financed, securing all amounts payable by the borrower under the refinanced home loan. (g) The refinanced home loan will either be in the form of a regular term loan or a line of credit. Where it takes the form of a term loan it will be linked to a 100% offset account into which all of the borrower's income (including that derived from the asset funded by the investment loan) shall be deposited for the purposes of reducing the interest payable by the borrower on the refinanced home loan. [2] Repayments of principal and/or payments of interest in respect of both the refinanced home and investment loans, as well as the monthly credit card balance owing in relation to a credit card used to pay all of the borrower's living expenses, shall be deducted automatically from the offset account. (h) Some of the key features of the refinanced investment loan are: • a maximum term of 30 years; • a minimum loan amount of $150,000 and a maximum loan limit of $1,000,000; • periodic instalments by direct debit of interest only for 10 years, before converting to principal and interest thereafter. The borrower will always have periodic instalment obligations and will not capitalise and compound the interest on the loan; • interest accruing daily at either a variable rate (generally a standard variable rate) or a fixed rate, within accepted industry margins; • the provision of the loan on a full recourse basis; and • the holding of a registered mortgage by the Funder over the asset financed, securing all amounts payable by the borrower under the refinanced investment loan. (i) The refinanced investment loan will not be a line of credit. (j) Neither of the refinanced loans: • are part of a linked or split loan facility as described in paragraphs 3 to 6 of Taxation Ruling TR 98/22; [3] • involve any capitalisation of interest; • are subject to any cross collateralisation; or • are part of an 'investment loan interest payment arrangement' as described in Taxation Determination TD 2012/1. [4] (k) At or around the same time as the refinanced loans are drawn, the borrower begins to participate in a monitoring program set up by Go Figure Calculators Pty Ltd under which the borrower is provided with: • software access to detail their income and expenditure budget for 12 months; and • initial assistance with the inputting of budget data and the evaluation and interpretation of their actual income and expenditure against that budgeted.

This Ruling is made on the basis of the following assumptions: (a) the borrower is an Australian resident for taxation purposes; (b) the investment loan relates to an asset held by the borrower for the purposes of gaining or producing assessable income, and the interest incurred by the borrower under that loan is deductible from their assessable income pursuant to section 8-1 of the ITAA 1997; (c) the borrower will not draw down on a line of credit to pay the interest on the refinanced investment loan, unless the borrower's refinanced home loan is a line of credit which is drawn down to make this payment, (d) all dealings between the borrower, ASHL, the Funders and Go Figure Calculators Pty Ltd will be at arm's length; and (e) the scheme will be executed in the manner described in the Scheme section of this Ruling.

The interest expense on a new loan will be deductible if the new loan is used to repay an existing loan which, at the time of the second borrowing, was being used in an assessable income producing activity (see paragraph 42 of Taxation Ruling TR 95/25 [5] referring to FC of T v. Roberts ; FC of T v. Smith 92 ATC 4380, at 4388).

Pursuant to the assumption at paragraph 20(b) of this Product Ruling, the borrower's investment loan is used in an assessable income producing activity. On the basis of that assumption and consistent with the principle set out in the above paragraph of this Product Ruling, interest incurred on the borrower's refinanced investment loan will therefore also be deductible under section 8-1 of the ITAA 1997.

Part IVA is a general anti-avoidance rule which gives the Commissioner the power to cancel all or part of a tax benefit that has been obtained, or would, but for section 177F, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In broad terms, Part IVA will apply where the following requirements are satisfied: • there is a 'scheme' as defined in section 177A; • there is a 'tax benefit' that, in relation to allowable deductions, is defined in paragraph (b) of subsection 177C(1) as a deduction being allowable to the taxpayer in relation to a year of income where the whole or part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; • having regard to the eight objective matters identified in subsection (2) of section 177D, it would be concluded by a reasonable person that there was the necessary dominant purpose of enabling the taxpayer to obtain the tax benefit in connection with the scheme; and • the Commissioner makes a determination that the whole or part of the amount of the tax benefit that is referable to the deduction shall not be allowable: paragraph 177F(1)(b).

The term 'scheme' is defined very broadly in section 177A to mean: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct.

The precise description of a scheme for the purposes of Part IVA will depend on the facts of the particular case. The circumstances described in paragraphs 16 to 20 of this Product Ruling constitute a scheme for the purposes of the definition set out in section 177A.

A tax benefit can arise to the borrower in relation to a year of income where the amount of deductible interest incurred on the refinanced investment loan is greater than the amount of deductible interest that would have been allowable to the borrower but for entering into the scheme described in paragraphs 16 to 20 of this Product Ruling.

The amount of the tax benefit in relation to a year of income would be the difference between the deductible interest incurred on the refinanced interest loan and the deductible interest that would have been incurred on the original investment loan if the borrower had not refinanced it under different terms.

Arrangements that include all, or a significant number of the elements which constitute either a linked or split loan facility described in TR 98/22, or an investment loan interest payment arrangement described in TD 2012/1, can attract the application of Part IVA to deny any deduction otherwise allowable under section 8-1 of the ITAA 1997 for interest incurred under a loan used for business or income producing purposes.

Whilst the borrower may derive a tax benefit in connection with the scheme described in paragraphs 16 to 20 of this Product Ruling, it is not considered that obtaining the tax benefit is the dominant purpose of the borrower in entering into the scheme and Part IVA will not apply to deny the borrower of a deduction allowed for interest incurred under the refinanced investment loan. In this respect, the critical elements of the scheme described in this Product Ruling (and which distinguish the scheme from the type of arrangements which are subject to TR 98/22 or TD 2012/1) are set out in paragraphs 19(h), (i) and (j) of this Product Ruling.

The following is a detailed contents list for this Ruling: Paragraph What this Ruling is about 1 Class of entities 4 Superannuation Industry (Supervision) Act 1993 7 Qualifications 8 Date of effect 10 Changes in the law 12 Note to promoters and advisers 14 Ruling 15 Scheme 16 Assumptions 20 Appendix 1 -Explanation 21 Refinancing an original loan 21 Application of Part IVA 23 Identification of the scheme 25 The tax benefit test 25 Dominant purpose 25 Appendix 2 - Detailed contents list 31