I was recently reading an article highlighting the tax implications of renting out a granny flat.
Whilst the article itself was interesting, it was the passing reference made to an old tax case that reminded me of a unique opportunity available to maximise interest deductibility on an asset purchase.
The case is known as Carberry’s case.
In this case, the taxpayers were allowed to apply their deposit only to their part of the property. Mr and Mrs Carberry were allowed a deduction for the full amount of interest on a loan used to purchase a combined dwelling/child-minding business, where it was shown that the whole of the loan related to the purchase of the business and the dwelling was purchased with the proceeds from the sale of their previous home.
Following the decision, the Tax Office released a ruling, IT 2661, which confirms their acceptance of the decision.
In the ruling, the Tax Office confirmed that the approach adopted by the Federal Court is accepted in the special circumstances of the case. Essentially, the issue involved whether it is possible, when a single asset is purchased using borrowings and there is a dual business and non-business purpose in the acquisition, to apply the whole of the borrowings to the business purpose and to allow a deduction for the interest paid on the whole of the borrowings.
According to the Tax Office, in certain cases, such as the Carberry case, a single asset may be capable of being properly regarding as being notionally divided between a part acquired with a business purpose and a part acquired with a non-business purpose. In such a case, borrowings may be properly regarded as relating to the notional part of the asset acquired for a business purpose and a deduction will be allowed for the full amount of the interest paid in respect to the borrowings.
However, for this method of apportionment to apply, it must be shown that the borrowings in fact relate solely to the notional part of the asset acquired for business purposes. In the Carberry case, for instance, the taxpayers were able to show that the part of the asset purchased for private purposes was paid for with the money which the taxpayers had received from the sale of their previous residence. Accordingly, it was open to the court to find that part of the asset purchased for business purposes was in fact purchased with the borrowing funds.
What we can see from this case is that there is some flexibility when purchasing an asset and using both existing cash and borrowed funds to maximise the deductible portion.
This can only be achieved when both your bank and your accountant are working together to ensure all the appropriate documentation is in place.
Should you wish to discuss the possibility of this strategy applying to your situation, please contact Ellingsen Partners.