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pugs
15-02-2005, 09:34 PM
Investment books comparing property and share investment often state that interest paid on borrowings used for purchase of shares is tax deductable - just as for rental property. However, I've never seen the principle carried through to any more comprehensive explanation.

My question applies to long term investment rather than trading. The objective would be to build a larger portfolio, for future dividend income, than could be achieved without borrowing. As with property, one could choose a range of approaches from loss making "negative gearing" through to more modest borrowings which could leave some taxable profit after deduction of interest from dividends.

Can anyone provide any practical guidance or comment on the requirements or processes involved in exercising this principle?

Thanks in advance .. Pugs

duncan macgregor
16-02-2005, 06:05 AM
PUGS, YOU cant have it both ways. Pay tax then claim tax. Or dont pay tax and dont claim. macdunk

stephen
16-02-2005, 06:44 AM
You can claim your tax on borrowings for shares if you are "long term" and not a trader, because the cost is incurred in achieving income from dividends. Of course, you will need to have some evidence to persuade the IRD that you are genuinely in pursuit of dividend income and not a trade, but you should have that anyway.

Macdunk is wrong.

(Note. I am not a lawyer or accountant).

Steve
16-02-2005, 06:45 AM
Pugs, if you borrow money with the INTENTION of using it to derive income ie:in this example, dividends from a long-term held portfolio of shares, then that interest cost will be a deductable expense in your tax return.

Put another way, you are borrowing money to generate dividend income, therefore deductable

Steve
16-02-2005, 06:47 AM
Look at that!...Steve & Stephen were writing the same thing at the same time! How about that?[:p]

duncan macgregor
16-02-2005, 07:03 AM
I would have thought it was like buying a property to live in and not trade or rent out. Like steven i am not a lawyer or accountant and might well be wrong. macdunk

zyreon
16-02-2005, 09:30 AM
interest is a cost neccessarily incurred in the course of business.

it is deductible.

KJ
16-02-2005, 12:03 PM
Pugs
From IR3G-income tax return guide:Expenses Pg 43

"interest on money you borrowed to buy shares or to invest-as long as the investment will produce some income that is taxable"

So you can claim for LT holdings as dividends are taxable or for short term trades.

KJ
16-02-2005, 12:22 PM
Pugs
Also look at thread "Some questions for Traders"-quite a lengthy debate on this subject.

Steve
17-02-2005, 11:44 AM
For those interested on the deductability of interest, a useful source would be the CCH Master Tax Guide. Section 10-120 Principles of Deductability.

One of the defining Court Cases is none other than BRIERLEY, for which we must all be thankful for.

limegreen
17-02-2005, 12:54 PM
Thanks for the reference Steve. Would you recommend tracking down the latest edition (it seems there is a very recently released 2005 ed. that hasn't made it to the library shelves here yet)?

pugs
17-02-2005, 10:28 PM
Thanks for the responses.

KJ - your reference to the other thread was useful, thanks.

Clearly very few people operate in this manner, even though the consensus is that interest on borrowings for investment (not trading)is tax deductable.

So, why is it that property investors routinely take the tax benefits but few share investors do the same?

e.g Borrowing $200,000 to purchase a $300,000 portfolio earning 6% dividend would be likely to leave a small taxable profit (dividends - interest). For an equivalent property investment, renting at $360/week = 6%, it is routine to borrow to make the investment and you would always claim the interest. Why do share investors not pursue this route?

Thanks,
Pugs

Steve
18-02-2005, 06:37 AM
Possibly because people don't realise that there could be benefits in seeking professional tax advice even for something as mundane as borrowing $$$ to create a share portfolio:

1)They see tax advice as a COST that they can avoid

2)They are NIAVE and don't realise that they are entitled to a dudection (possibly thinking only for property/business[?])

3)There are currently no GET-RICH-QUICK SHARKS out there promoting it (for a $2,500 advisory fee, of course;)) Note to self:New 'business' idea - must put ad in paper to feed off the suckers

4)Let's face it, the IRD are not going to tell you that you can do it

zyreon
18-02-2005, 09:49 AM
10-115 Master Tax Guide for students
"Interest is deductible so far as the Commissioner is satisfied that:
-it is payable in deriving the taxpayer's gross income (see s DD 1(1)(b)(i));
-it is neccessarily payable in carrying on a business for the purpose of deriving the taxpayer's gross income (see s DD 1(1)(b)(ii)); "

my interpretation is that if the capital is employed in deriving taxable income e.g. dividends for investors OR profits for traders.
It seems as though if one is employing the capital in order to produce only tax free capital gains then the interest expense will not be deductable.

So if the income is taxable the expenses (if neccessarily incurred in producing that profit) are deductable.

e.g.
Trader:
Sales from operations 1 000 000
cost of sales (including brokerage) 900 000
Gross profit 100 000
less expenses (allowable deductions)
e.g.
interest 10 000
research 1 000
stationary 200
internet and phone 200

net taxable profit (being revenue less deductable expenses)
88 600

Then multiply net taxable income by appropriate tax rate etc etc.

Investor
dividend income 10000
interest expense 5000
net taxable profit 5000

then times by appropriate tax rate e.g. 33%
if so: tax liability = 1650
deduct RWT paid on dividends of 3300

tax credits owed to tax payer = 1650


and for goodness sake if in doubt see a tax consultant or CA - any fee they charge you will most likely be a deductable expense.

limegreen
19-02-2005, 01:07 PM
OK. I'm very curious about this, and will do some further research and probably seek professional advice. I'm a long term investor, but currently have more equity in the market than I do in my house. I had been planning to re-weight my portfolio away from dividend yielding companies into growth companies as much as possible. However, assuming that I could claim portions of my mortgage interest against high dividend yield investments, this would make them look far more attractive. Does this sound reasonable?

Steve
19-02-2005, 05:29 PM
quote:Originally posted by limegreen

OK. I'm very curious about this, and will do some further research and probably seek professional advice. I'm a long term investor, but currently have more equity in the market than I do in my house. I had been planning to re-weight my portfolio away from dividend yielding companies into growth companies as much as possible. However, assuming that I could claim portions of my mortgage interest against high dividend yield investments, this would make them look far more attractive. Does this sound reasonable?


If you took the mortgage to purchase your house, then you would be unable to claim any portion of it against your share portfolio.

If you took out a seperate mortgage and used these new funds to buy the shares, then it would be claimable.

limegreen
21-02-2005, 09:32 AM
Bugger. So that would be true even if I could have sold the stocks in order to buy the house, rather than take out a mortgage?

Steve
21-02-2005, 12:17 PM
True. You took out the mortgage to purchase your private residence. Having shares that you could have sold and use the proceeds towards the house purchase is now irrelevant.

limegreen
21-02-2005, 01:27 PM
Cheers. The key stock in question is SKX, funnily enough as we've been discussing elsewhere. Unless it breaks 135, I don't rate it's chances of outperforming my mortgage.

Umm, just one last question if I may. Part of my mortgage is revolving credit. Thus, if I draw down money that I had previously paid off, would that count as borrowing for the purpose of share acquisition, too dodgy, or do I need to seek professional advice.

Scrunch
26-02-2005, 11:11 AM
As I see it Steve & Limegreen have hit the nail on the head. You can claim interest but the combination of events necessary is unusual. If you borrow via a leveraged facility that some investment banks offered you can claim the interest but the interest rates of 300bp to 500bp above 90 day bank bill rates are not appealing. The additional interest paid beyond say using a mortgage offsets most of the tax gain. If you use your house as security, you need to have effectively repay part or all of your mortage then redrawn to invest. Possibly an option for some when changing banks.

Assuming you have a share portfolio larger than your mortgage, most investors don't want to sell it, repay the mortgage then reborrow the mortgage to buy the shares back as all the trades necessary could attract the IRD and tempt them to assess you as a trader, and pay on all the previously unrealised capital gains.

If you have ever tried to arrange a share secured personal loan through the banks, its not worth the hassel. Either you only get a comparatively small loan eg 20K or you start needing to transfer the security to their trustee services and pay admin fees.

Recently I met an old friend who had just undergone a separation, and for those in this unfortunate situation it does give a reason for selling all investments, crystalising capital gains before subsequently rebuilding a portfolio with some deductable debt funding

Hope this is of some assistance
Scrunch