Speaking to InvestorDaily, Halsey Legal Services principal Mark Halsey said he has recently been involved in negotiating an enforceable undertaking between the ATO and a financial advice firm in relation to the type of arrangement described in Tax Determination (TD) 2012/1.
Mr Halsey said the arrangements that fall foul of the tax office typically involve a client who owns at least two properties with outstanding mortgages – one of which is a principal residence, and the other an investment property.
“The structured early debt repayment program recommended by financial advisers typically involves ensuring there is a principal and interest loan on the client's principal residence, an interest-only loan on the investment properties and an additional loan facility such as a line of credit or similar borrowing facility,” said Mr Halsey.
The line of credit is drawn down to pay the interest on the investment loan as it falls due, but no payments are generally made on the line of credit unless required, he said.
Because the line of credit can be claimed as a tax deduction, it is allowed to capitalise and compound – while all of the client’s available cash is used to pay down the non-deductible debt on their principal residence.
The net benefit of the restructured debts is to shorten the time it takes to repay the loans, as well as reduce the aggregate amount of money paid in interest.
TD 2012/1, which relies on the 2004 Hart Case, states that the ATO regards such schemes as unlawful Part IVA tax avoidance – regardless of a taxpayer’s claimed motivation of entering into the arrangement for the purpose of ‘paying off their home loan sooner’ or ‘owning their home sooner’, said Mr Halsey.
“Despite the fact that the ATO has expressed concerns about this and broadly similar arrangements dating back to 2000 … there nevertheless appears to be a concerning level of non-compliance in this area. Much of that non-compliance appears unintentional,” he said.
"Apart from the problems experienced by the clients, the consequence of non-compliance in this area can be catastrophic for the financial adviser" Mr Halsey said.
The ATO can commence from the position that the financial adviser is a ‘scheme promoter’, which can trigger a variety of civil and criminal sanctions and penalties against the adviser, he said.
Along with adverse effects on current and future professional indemnity arrangements, the adviser can be compelled to name the clients who have been recommended an early debt repayment strategy, said Mr Halsey.
“The ATO may then contact those clients, investigate whether actual breaches have occurred and carry out enforcement action against them, where appropriate,” he said.
It goes with saying that such remedial action would have an “extremely detrimental impact on the relationship between the financial adviser and their clients,” he added. “In addition, if clients take action in the courts or via the Financial Ombudsman Service against the planner, they would almost certainly receive compensation.”
A spokesperson for the ATO encouraged advisers and clients who think they might be in contravention of the TD 2012/1 to contact the tax office “as early as possible to discuss their position”.
