Common misconceptions with claiming interest on investment finance…
In most instances, financing an investment is straight forward: money is borrowed, the investment is purchased, investment produces income and any interest paid will generally be deductible under S. 8-1.
One road hump, which has been highlighted recently and is important to note, is that interest is only deductible to the entity/individual that incurs the costs. Therefore, the investment loan must be in the name of the entity/individual that owns the investment. If the investment loan is not in the name of the correct entity/individual, then interest is not deductible to either entity/individual as they have not incurred the interest or the interest cannot be tied to producing income. In some instances, where the above cannot be avoided, on-lending between entities/individuals under the same terms will at least provide a case to show reasonable steps were made to correct the finance into the correct entity/individual.
Where the waters can become muddy and claiming the interest on the loan may not be deductible is where the loan is redrawn and the funds are used for private purposes. In this instance only the percentage of interest which relates to the original debt can be claimed. The same application applies with repayments, where an investment loan is redrawn and funds are used for private purposes then repaid shortly after, the repayment is not applied to the private portion of the debt rather divided across all the debt on a proportionate basis, thereby meaning interest can never be 100% deductible on the related loan.
An effective strategy to resolve a mixed loan problem is to refinance both loans accordingly, which will enable principal repayments to be allocated as wished. Another alternative is to avoid the mixed loan problem all together via the use of an interest offset account. Under a interest offset account arrangement, the interest payable is calculated based on the original debt less any funds in the interest offset account. Therefore, if a balance of funds is kept in the interest offset account (via exceeding the minimum periodic repayments) they can be drawn on without effecting the deductibility of the loan.