The Dangers in Drawing Down a Loan into an Offset Account

When I was recently researching some tax questions for myself, I came upon this article and thought it could be handy for some clients.

The basic rule is – what the borrowed money is used to buy determines whether the interest on the loan is tax deductible. The link between the borrowing and the expenditure is called the nexus. This nexus needs to be very clear. You need to be able to show exactly how the money borrowed was used to purchase an asset that is producing income. For the interest on a loan to be tax deductible it must be a cost of earning taxable income.

The danger with offset accounts is that funds withdrawn from the loan and placed into the offset account can lose that nexus with the loan, if they sit there too long or are mixed with other funds. A principle established in Domjan’s case AAT 2014 is that once borrowed funds are mixed with private funds the nexus is lost.

Wilma Domjan withdrew money from her loan, deposited it into her cheque account and then wrote cheques to pay for work done on her rental property. In all but one case there were already private funds sitting in the cheque account. The court ruled the nexus between the borrowings and the rental property was lost. The borrowed funds were mixed with private funds so the borrowings were for private purposes, no tax deduction on that portion of the loan interest. There was one exception, when she drew money from the loan account and deposited it into her cheque account, there were no other funds in the cheque account at the time of the deposit, right through to when the cheque, for rental property repairs cleared. In this case the court decided that the borrowing was for tax deductible purposes.

Accordingly, you may get away with drawing loan funds down into an offset account to very promptly pay for a tax deductible expense if the account has nothing else in it during that time. Don’t let the money sit around while, say you look for a property, just incase the ATO views them as having become savings. Further, do not deposit anything else in that account while the borrowed funds are there and certainly don’t draw on it for private purposes, not even a little. I haven’t been able to find it but I did have an informal guidance from the ATO saying that they would be ok if the money went from the loan into an empty office account and then paid for the income producing asset but if it hung around there was no getting around the fact that the offset account is a personal savings account and that is where the borrowed money went so no nexus when the money is finally used. Considering the amount at stake and the period of the loan I would prefer you take no chances and do not draw on these loans until the money can go straight to the settlement on a new property. This may mean delaying refinancing.

If you have used a loan for private purposes, then you need to repay it right down in the loan account (not the offset that is just a separate savings account) if the loan has been paid off then you redraw for deductible purposes the interest will be tax deductible.

As mentioned at the top. These are not my words nor my article so please seek your own advice from a taxation professional.

Sourced from www.taxquestions.com.au

This information has been prepared by PHA Financial Services and does not take into account your objectives, financial situation or needs. Before acting on this information you should consider whether it is appropriate to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. The information provided was accurate at the time of publication and changes in circumstances after a document is published may impact on the accuracy of information. Some information may have been collated from various third parties and we make no assertion that the information was originally ours.