Avoid the Two most common and biggest mistakes in finance structures: Tax planning your finance strategy

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Firstly, thank you Mr Tax Man!

Did you know that the ATO supports us in ensuring we have maximum tax efficiency in the way we run our businesses and investments, Why is that? Tax efficiency helps to lay a firm basis for financial stability and a profitable (taxable) business, a growing investment portfolio and, hopefully, self-funded retirees further down the track.

When June 30th ticks over this year how many of you will have taken proactive steps to plan for a tax efficient finance structure in the 2014 Financial Year just completed?

We trust that a high portion of you have given a resounding “Yes!” to that question because, in terms of your own cash flow in the coming year, that sort of planning can make a big difference.

If you answered “No” then, even at this late stage of the financial year, there are some actions you can take to improve tax efficiency in the current year (see below).

The big savings, however, could flow in to you in Financial Year 2015 if you take a few moments to alert yourself to the common mistakes (set out below) we see in the financial structures of some of our investor clients.

 

Below are TWO BIG mistakes we see frequently and also several tax related issues that it’s wise for us to be aware of. Check your own loan structures to see if they might apply to you! If that is the case be proactive and take steps to correct the mistakes and look forward to a better result in FY 2015!
One of the most popular short term tax savings strategies you can employ at this stage of the financial year is to pay interest in advance (IOA) on loans being used for business and investments. Paying next year’s loan interest in June this financial year is an excellent way of bringing forward a tax deduction that you would normally only incur after the close of the 2015 Financial Year. Many lenders offer a one year fixed rate IOA and they generally give a 0.1% discount off the normal one year fixed rate if you pay in advance. Your accountant can use that interest in advance payment as a current financial year’s tax deduction.
WARNING: Time deadlines apply! Lenders will require an application to be in to them in the first part of June. If you would like to take advantage of this strategy it is important that you call us in May so we have time to check what’s on offer and lodge the relevant application form.
Are you paddling a leaky boat? We affectionately call this the “leaky sieve syndrome” – the common mistakes that allow your funds to be depleted, often in unintended ways months or years after the events that set the mistakes in motion.
 

  • Mistake 1 – Unintended or incorrect borrower on a loan
    Some months ago Sam and Christine purchased a negatively geared investment property in a trust. Sam was the highest income earner of the couple at the time and after discussions with the accountant it was decided that Sam should be the borrower on a loan to purchase the property and that the trustee company and Christine would be guarantors to the loan. With this structure tax efficiency was kept in mind with the interest on the borrowings an allowable tax deduction for Sam. Loan offers were signed and all seemed to be in order. Sam provided his loan statements to the accountant to prepare tax some months later and the accountant came back to him with the news that the tax deductibility of interest paid on the loan lay within the trust and not with Sam. The loan statement described the borrower as “Sam IOR and as trustee for the trust”. (IOR is an abbreviation for In Own Right) In essence this means that both Sam and the trustee are contracted as borrowers and, in this case, tax deductions for interest paid will be attributed to the trust. The mistake of an unintended or incorrect borrower on a loan is common place. Interest Sam paid was $20,400 annually. Expected deduction for Sam had been approximately $7,000 and was now at $ zero. Costly mistake.

    • A quick read of the Loan Contract before signing is insufficient. Whilst Sam did not understand the impact of having both himself and the trust as borrowers or the meaning of the abbreviation “IOR” a professional involved with property and finance would have picked this up – have the document description of the loan structure in your Loan Offers checked by the accountant who recommended the initial structure.
    • Take preventative action – engage with a broker who your accountant has briefed on the structure and who therefore understands the intended tax result of the loan structure. Chan & Naylor professionals work in a team and consult with each other to ensure your structures are correct. Our strategists monitor the lender as the loan application progresses and correct any bank misinterpretations of a requested loan structure.Did you know that 30% of Loan Offers issued by lenders contain errors that require reissuing of documents?

      If you use a solicitor to check documents they may not be aware of the tax planning you have underway with your accountant. They are checking Loan Offers and Guarantor documents for legal correctness and not tax efficiency of structuring.

If you suspect you have an incorrect structure let us look at it and correct it where need be.

  • Mistake 2 – Mixing purposes in the one loan
    Maddy has set up a line of credit (LOC) from which she pays expenses for her investment property. She has heard that loan interest on the LOC can be reduced by having her pay directed into the LOC to internally offset interest on that loan. Sounds like an excellent idea! Maddy pays her everyday living expenses on a credit card that she clears monthly with funds from the LOC, after all, that’s where her monthly pay is sitting and offsetting interest on the loan. The mistake here is mixing purposes in the one loan. Maddy mixed personal and investment use into the one LOC thereby contaminating its purpose. This system works well only where the purpose of the LOC is all personal OR all investment. It’s virtually impossible to tease out which interest is attributable to investment and which to personal in Maddy’s scenario and if deductions have been claimed they could potentially be clawed back in a tax audit. It is highly likely that a tax audit by the ATO will result in any claims for deductible interest, assessed retrospectively, being disallowed by the ATO.
  • Ensure your personal use loans are separated from your investment use loans. 
  • Where you want to offset interest on investment loans use an offset account to hold pay and savings so that these funds are never mixed with the investment loan account directly.
  • If you have mixed purpose loan accounts bring them to us for restructuring and tidying up. 
  • Other tax related issues that crop up frequently: 

    • Names on title when buying an investment property. If you buy together with another person (e.g. sibling, friend or joint venture partners) be aware that tax deductibility on the loan follows the ownership percentage you hold as does distribution of rental income. It cannot be varied from year to year as your financial situation changes.
    • If the lender has issued your Loan Offer with an incorrect/unintended borrower and you have not the time to ask for documents to be reissued because of an impending purchase settlement date, speak to us immediately about obtaining an On Loan Agreement which can help correct this mistake from a tax planning point of view.
    • Accumulated unpaid tax liabilities attract a 9.6 % general interest charge from the ATO. Mounting tax liabilities can be financed away from the ATO with some lenders and often at a lower interest rate. Generally this type of loan needs to be secured by real estate so a refinance to a suitable lender may be required.
    • Your borrowing capacity includes in its assessment interest you may be paying for tax liabilities and lenders require visibility these days on your current tax liabilities. Lenders can ask for copies of the tax portal for your business and Tax assessment notices for your personal returns.

 

Whilst preventative steps are the wisest way to go, sometimes there are slip ups for all of us. Learning moments so to speak! Mistakes can cost you dearly, but most can be corrected. The reward is likely to be a better cash flow for you in future years.

You are welcome to send us an email if you have a scenario that you would like us to look into.
Happy tax efficiency planning!

Jenna Ford - Chan & Naylor Finance

Disclaimer: This article contains general information. Before you make any financial or investment decision you should seek professional advice to take into account your individual objectives, financial situation and individual needs.

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