Australia: The Last Word on Split Loans?

Last Updated: 8 June 2004
Article by Anton Joseph
The High Court in Australia has finally made its decision in the case of Commissioner of Taxation v. Hart1, reversing the decision of the full Federal Court delivered in July 2002. The High Court decision is a fatal blow to the use of a split loan in a particular manner to purchase a home and an investment property. (See previous related article of 8 August 2002 - "Hart of the Matter - the Role of Split Loans" by clicking on the "Next Page" link at bottom of this article). The loan provided by the lending institution that came under scrutiny was aptly called the "wealth optimiser".

The relevant section of the loan agreement stated as follows:

"While the Loan Amount is split into loan accounts:

  1. this agreement applies to each loan account as if the balance of each loan account was a separate loan made on the same terms and conditions as the loan under the agreement. For example, interest will be calculated on the balance of each loan account and debited to each loan account; and
  2. We will credit all payments received by us under or in connection with this agreement among the loan accounts as requested by you.

Repayments made by the taxpayers were credited to the home loan account , thus gradually increasing the interest payable on the investment loan account, which resulted in lowering the taxable income of the taxpayers. In effect, the interest that would have been chargeable to the home loan account was transferred to the investment account, whereas interest on the home loan account was not deductible for tax purposes.

In determining what was the dominant purpose of the taxpayers entering into the split loan agreement the High Court said:

"The "wealth optimiser structure" depended entirely for its efficacy upon tax benefits generated by arrangements between the respondents and the lender that had no explanation other than their fiscal consequences. What "optimised" the respondents' "wealth" was the tax benefit earlier described: not the deductibility of interest as such; but the deductibility of additional interest on loan account 2 contrived by the particular form of the borrowing transaction."

In other words the High Court held that the dominant purpose of the taxpayers in entering into the spilt loan agreement was to gain a tax benefit, contrary to the view held by the full Federal Court that the dominant purpose of the agreement was for a commercial purpose.

The 3 elements that must be established for the anti-avoidance provision to apply are:

  • there must have been a scheme;
  • the dominant purpose of the scheme must have been to obtain a tax benefit; and
  • there must have been a tax benefit

The first step in investigating whether there had been tax avoidance is to identify the scheme that had resulted in the tax benefit to the taxpayer. There had been instances where the revenue authorities failed in establishing avoidance due to identifying the wrong scheme.

The general anti-avoidance provisions sets down the following as the factors that should be taken into consideration when determining the nature of the purpose of the taxpayer in entering into the scheme

  • the manner in which the scheme was entered into or carried out;
  • its form and substance;
  • the particular time at which the scheme was entered into and the period during which it was carried out;
  • the tax result that, but for the anti-avoidance provision would be achieved by the scheme;
  • any change resulting from the scheme in the financial position of the taxpayer;
  • any such change in the financial position of a person with whom the taxpayer has business, family or other connections;
  • any other consequence of the scheme for the taxpayer or a connected person;
  • the nature of any connections between the taxpayer and a connected person whose financial position changes as a result of the scheme.

These factors had to be considered when deciding whether the dominant purpose in entering into the scheme was to be obtain a tax benefit.

The section of the explanatory memorandum to the amendment to the Income Tax Assessment Act 1936 that introduced the general anti-avoidance provision read as follows:

""The proposed new Part IVA, which this Bill will insert into the Principal Act, is designed to overcome [limitations on the scope of s 260, as exposed by judicial decisions] and provide - with paramount force in the income tax law - an effective general measure against those tax avoidance arrangements that - inexact though the words be in legal terms - are blatant, artificial or contrived. In other words, the new provisions are designed to apply where, on an objective view of the particular arrangement and its surrounding circumstances, it would be concluded that the arrangement was entered into for the sole or dominant purpose of obtaining a tax deduction or having an amount left out of assessable income. "

The relevant ant-avoidance statutory provision reads as follows:

"177A(5) [Purpose of scheme]

A reference in this part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shell be read as including a reference to the scheme or part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose."

In its media release (28 May 2004) the Australian Tax Office says:

"The unanimous decision of the Court confirms the effectiveness of the general anti-avoidance provisions in protecting the integrity of our tax system," Mr Carmody said.

"Importantly the Court, in its reasons for its decision has given substantial guidance to the Tax Office and the community about the operation of the general anti-avoidance provisions."

The Commissioner pointed out that people who already have these types of loans to finance their investment property, will still be able to claim the portion of the interest that directly relates to the investment part of the loan."

Does this decision spell the end of commercially motivated schemes that result in tax advantage? It is difficult to agree that it would. Each case involving alleged tax avoidance depends on the particular facts surrounding it. In this case, the taxpayers were husband and wife and investment in a second house could hardly be described as a business venture in the conventional sense of the word.


1 [2004] HCA 26 (27 May 2004)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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This article is part of a series: Click Heart of the Matter- the Role of Split Loans for the next article.
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