Document written by Martin Bell , MRD – Capitalising Interest

It is a tough job for simple people like me to unravel the logic or meaning behind Tax Rulings at the best of times; but when the ATO goes and uses words like “impecuniosity”, I scream “plain English please!” I suppose it is actually a good thing when we are given the opportunity to expand our vocabulary; which I did recently when reading up on the whole subject of the “tax deductibility of capitalised interest”.

For many years I have capitalised my investment property expenses. Managing a portfolio of 13 properties has meant the interest rate rises of recent years had the potential to “hurt a lot”. Not having to pay those many expenses from my cashflow has been the difference between sailing through the storm or being shipwrecked along the way!

Having taken clear instruction from my accountant on this subject, I have always done the “right things” by the ATO. I keep a separate Line of Credit for all my investment property expenses; such as rates, body corporate levies, maintenance and so on; allowing me to preserve/protect my cashflow. I have always been diligent to pay the interest on our 13 loans from a personal (non tax deductible) Line of Credit. This is because of my understanding that to claim as a tax deduction any capitalising of interest would be to cross the line with the ATO.

It would appear, however, that recent rulings (PBR 80938, 79493 etc) have determined that it is perfectly OK to claim as a tax deduction any capitalisation of interest payments for an investment property (as with the related property expenses) on the condition that:

• My loans are kept separate and
• My primary reason for doing so is not to reduce my tax liability. That is, it is not part of a “split loan” which aims to pay off personal debt (such as a home loan, e.g.) faster.

Hanging over all of this, however, is “Part IVA”; which reads: “The incurring of compound interest depends upon a decision not to pay simple interest as it falls due. Sometimes such a decision will be compelled by impecuniosity”. My understanding of what this is saying is that if anything is done with a “dominant purpose of a tax benefit” it is not allowed. Where the word “impecuniosity” turned up (a word that neither my spell check or I were familiar with) is in a statement from the ATO that simply means you are too poor and cannot afford to pay.

My personal choice is to continue to make all interest payments from personal funds, only capitalising my property expenses. Like anyone I am allowed to capitalise my interest payments; I just cannot claim the interest on interest as a Tax Deduction; unless I found myself between a rock & a hard place unable to keep up with my payments and facing the prospect of a forced sale. Rather than falling victim of such drastic action, I would make application to the ATO for a “Private Ruling”.

Q: Why a “Private Ruling”?

A: Because if the ATO decides it can deem my action (to claim as a tax deduction capitalised interest), as taken primarily to avoid tax they will disallow the claim; and probably fine me.

Without a private ruling I would have to demonstrate to the ATO my impecuniosity.