Keeping the Nexus When Refinancing

Question

I have a loan for an investment property with Westpac for $220,000.

I also have an unused loan facility with ANZ for $220,000.

I want to transfer the $220,000 loan amount from Westpac to ANZ as ANZ is about 1% cheaper. The WBC loan facility will be kept and used for other personal purposes.

So it would mean drawing down on the ANZ facility and transferring the funds to the WBC facility so the ANZ interest will be deductible as its purpose was for the purchase of an investment property.

The problem is neither bank will allow the funds to be directly transferred out of a loan account into another loan account i.e. to get the funds from the WBC loan to ANZ loan the following has to happen:

1. $220k drawn down from ANZ facility and transferred to an ANZ savings account
2. The $220k is then transferred from the ANZ savings account to a WBC savings account
3. The $220k is then transferred from the WBC savings account to pay off the WBC loan.
4. Interest is now payable on the ANZ loan

This is very convoluted but it is the only way both banks will do it.

I have heard the ATO is funny about breaking the nexus between the purpose of funds and their deductibility. I will ensure the WBC and ANZ savings accounts don’t have any other funds coming in or out i.e. I will open savings accounts specifically for this transaction & then close them.

Do you think there will be a problem with the above should I get an audit or should I request a private ruling from the ATO so there is no problem with the $220k being deductible – before I do the transfer?


Answer

My first line of action would be to talk to Westpac about their interest rate. They are quite aggressive in that department. Further, if you intend using the freshly cleared Westpac loan for private purposes wouldn’t it be better to save the low-interest loan for your own non-deductible use?

I am concerned about the use of savings accounts along the way. It is not just a fly under the radar on the day, this will continue for the whole life of the loan. You are on the right track with the clean bank accounts. It is also important that the money never lollygags in the accounts. Quick same day transactions are the best.

I would still go for a ruling because there is so much at stake. Afterall if you get a negative response from the ATO you would just simply not go ahead with the strategy. Better than being on the back foot with a difficult auditor.

The reason I write so much material about not breaking the nexus is because it is too hard to fix by the time the Accountant finds out about it. So my aim is to just scare everyone away from anything other than straight forward refinancing. The basis of my concern is Domjan’s case where Wilma withdrew some money from her loan facility, deposited into her cheque account and then paid her builder. The court found that once the borrowed funds were mixed with her other money the nexus was lost. On one occasion it was shown that there was no money at all in the cheque account when the borrowed funds went in. Interest on that borrowing was allowed. So Domjan’s case will support your argument that clean bank accounts to not break the nexus. That would be the main thing I would rely on in your ruling application. Here is a link to the case. https://www.ato.gov.au/law/view/document?docid=JUD/2004ATC2204/00001 In particular:

38. The drawdowns are set out above at paragraph 21. It is clear that in most instances the funds drawn down were deposited in Mrs Domjan’s Westpac cheque/savings account number 51-7856. In all but one instance when funds were deposited to the cheque/savings account that account had been in credit balance. Thus the drawn down funds were intermingled with funds already in that account.

You might also refer to TR 95/25 where the ATO state that a rigid tracing of funds is not necessary https://www.ato.gov.au/law/view/document?Docid=TXR/TR9525/NAT/ATO/00001

In particular:

Use test

26. As Hill J stated (Roberts and Smith ATC at 4388; ATR at 504):


‘As the cases, including Kidston, all show, the characterisation of interest borrowed will generally be ascertained by reference to the objective circumstances of the use to which the borrowed funds are put. However, a rigid tracing of funds will not always be necessary as appropriate.’

Also

https://www.ato.gov.au/law/view/view.htm?docid=EV/1013097177868&PiT=99991231235958

The ‘use’ test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest and looks at the application of the borrowed funds as the main criterion.


Interest on a loan taken out to refinance a loan used to acquire an investment property is deductible to the extent it refinances the balance outstanding that directly relates to the original acquisition of the rental property or it is used to finance other income-producing activities.

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