ATO warns about home loan refinancing scam

In the normal course of events, home loan repayments, including the interest on them, are not tax deductible (unlike in the US where interest on home mortgages can be deductible). However, from time to time, schemes seem to surface that seek to make such interest payments tax deductible.

As mortgage repayments are a huge financial cost for those who have to make them, they may be tempted to participate in such schemes to help pay off their home loans sooner, or to get tax deductions they didn’t think they could otherwise obtain. This may be even more so given the expectation that mortgage interest rates are about to rise again. But beware!

The Tax Office has recently warned people about what it says are sham arrangements promoted as “mortgage management plans” which promise to help home owners repay their home loan sooner and claim tax deductions to which they are not entitled.

The naming of these kinds of schemes can sound attractive and quite innocent, but people need to be aware of what sits behind the arrangements.

The warning, in the form of Taxpayer Alert TA 2009/20 – Interest deduction generators involving promoter controlled companies – describes an arrangement the ATO says seeks to generate interest deductions for people through refinancing their existing home loan and establishing purported investment loans to fund the purchase of shares in companies controlled by the promoter of the arrangement. The taxpayer claims large deductions for the interest purportedly incurred on the investment loans.

Tax issues of concern to the ATO include the possibility that certain loans may be shams, whether deductions for interest are allowable under the tax law, and the possible application of the anti-avoidance rules.

What to look out for

The warning from the ATO applies to arrangements which may have features broadly as follows:

• A promoter approaches someone offering an investment plan involving investments in foreign companies, partly funded by re-financing of the person’s existing home loan equity. Generally, the people targeted do not understand the operation of the arrangement and the promoter or their associate provides advice to help guide them.
• The promoter arranges for the individual to refinance his or her existing home loan through a third party financial institution.

 – Under the new loan, the taxpayer obtains two loan facilities: a home loan (Loan 1) for the outstanding balance on their previous home loan; and an interest-only investment loan (Loan 2).
– The Loan 2 amount is the maximum offered by the third party financial institution having regard to the equity in the taxpayer’s home. Both Loans 1 and 2 are secured over the taxpayer’s home.

• The taxpayer makes the principal and interest repayments on Loan 1. The promoter undertakes to pay the interest on Loan 2 on behalf of the taxpayer.

• The promoter arranges a purported unsecured investment loan (Loan 3) for the taxpayer.

– Loan 3 is provided on non-commercial terms by an entity controlled by the promoter, including either no recourse or recourse limited to the shares in the promoter controlled company.
– The Loan 3 amount is well in excess of the taxpayer’s borrowing capacity under normal arm’s length lending criteria.

• Funds from Loan 2 and Loan 3 are purportedly used to purchase shares in various companies controlled by the promoter. None of these companies appear to be carrying on a business or otherwise producing assessable income, the ATO says. Generally, the taxpayer does not derive any dividend income from the purported share investments and, in all cases, appears unlikely to do so in the future.
• The taxpayer claims the interest incurred on Loan 2 and the interest purportedly incurred on Loan 3 as allowable deductions. In addition, many taxpayers may also seek to obtain a PAYG withholding variation to reduce the amount of tax deducted from their salary or wages during the course of the financial year.

The benefits – tax and otherwise – can all be made look very attractive.

ATO is contacting people

The Commissioner said these arrangements are essentially about people refinancing their home loan and establishing what appears to be an investment loan to fund the purchase of shares in a bogus company. He said the Tax Office is currently contacting over 140 people involved in these arrangements asking them to review their circumstances and inviting them to make a voluntary disclosure where necessary.

Some schemes can simply look too good to be true – and they often are.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.

For more Terry Hayes features, click here .