Tax Tip 134: The Gift and Borrow Back Strategy and Tax

The Gift and Borrow Back Strategy and Tax

The gift and borrow back strategy is often used as an asset protection strategy. I have written about this here:

Legal Tip 115: The Gift and Borrow Back Strategy, Part 1


There are generally no taxes on gifts. See my thread on this Tax Tip 57: Gift Tax


But there are tax issues on any interest on the loans coming back.


Where interest is charged by a lender this will be income to that lender.


Example

Mum lends Son $100,000 at 10% pa. Mum will earn $1,000 per year in interest and she will pay tax on this as it is income. This is pretty straight forward.


But there are potential issues for the borrower to claim a tax deduction on the interest where the origin of the money borrowed is the borrower.


Example continued

The son would pay mum $1,000 in interest, this would be deductible to the son, under s8-1 ITAA97, if the son has borrowed for the purposes of investing. But the ATO has powers to deny the claiming of a deduction where it is a scheme with the dominant purpose of a tax benefit (Part IVA ITAA1936). So the ATO may deny the deduction of interest to the son.


I believe the ATO would likely deny the interest claimed by the borrower in situations like this, especially in the early years after a gift is made. This would probably be the same whether the gift giver gave the money to a parent, a spouse or a discretionary trust. As time passes there would be less likelihood of this occurring, assuming that a property arms length loan agreement is entered into.


Therefore, if you wish to borrow back the money you have gifted someone and if you wish to claim the interest on this loan you should seek your own private binding ruling before doing so.


Where the loan is interest free there should be no tax issues like this.


Incidentally, an interest free loan can still be a legally valid loan and legally binding.

 

Hi Terry,

Just read this post. Very interesting thank you. Presuming this is up to date, a I think it will certainly apply to me shortly.

We are in the process of buying land. Exchanging Monday I hope.
We then plan to move an existing house on to the land.
My wife's dad has kindly offered to lend us the money to move the house - roughly $100,000. Very generous indeed.
Having read your tax tip above am I right in saying:
- there is no limit on the amount of a "gift" one can receive?
- the $100,000 "gift" is not counted as income and WE can't be taxed on it?
- if, once we have done the move and a couple of years down the line we were to repay the $100,000 "gift", my father in law would also NOT be taxed on it.
- If however we were to repay $110,000, my father in law would be liable to pay income tax on the $10, 000......... Unless we were to "gift" it separately?

Have I got that right?
Anything I need to be careful of here?
Thanks in advance.

 

- no
- not necessarily
- not necessarily
- not necessarily

heaps to be careful of hear.

Seek specific legal advice.

 

Hmmmmm. Ok. I'm a little confused then.

 

Gifts may be tax free. But is this a gift or a loan? Should it be a gift or should it be a loan?
There are also a large number of tax and legal issues to consider - you don't know what you don't know so seek legal advice - from a lawyer.

 

Ok. It would be a gift from dad in law.
Should we be able to afford to sell one of our other IPs in the future, we would consider gifting him some of our profits.
Since he is not working, we could also consider gifting him $200 a week for an extended period of time.
(Tax Tip 57: Gift Tax).

 

What are the consequences of this for him and you?

 

Consequence for him is that he'll have $100,000 less in his bank account. Won't have to borrow in order to make his gift.

Consequence to us would be it'll allow us to move a house onto land we already own in which we will finally live in. Not another IP. It'll be our PPR which will mean we have to sell our current PPR within 6 months to avoid CGT.

 

They are some consequences.
What about
- family law
- bankruptcy
- death
- asset protection
- disputes
etc

 

This, I'm afraid, I'm ignorant of.

 

Although I'm trying to learn:
Legal Tip 120: Properly Documenting Gifts

 

Hmmmmm.... Very interesting Terry.
We are having father in law round for dinner tomorrow and discuss these points.

Although I need to look further into tax implications on "Loan", it appears that both options might be viable. Depends on what we as a family agree:

Should father in law declare the $100,000 a gift to us and that he doesn't want it back, then we should protect him and us by putting it in a deed, which I guess any legal professional has to draw up. No tax implications here at all.

Should we insist on repaying his kindness in helping us out, we might do better considering declaring it an interest free loan. Again I presume putting this in a deed drawn up by a legal professional would document this appropriately.
No interest = no tax implications for both sides here as well?

Am I getting close....?!

 

Generally yes but seek legal advice