Borrowing to buy shares – the hurdles that lie ahead!

Written by Bob Deutsch, CTA, Senior Tax Counsel

In light of Labor’s proposals in relation to negative gearing and imputation credits, I thought it might be useful this week to revisit a common but somewhat risky investment strategy whereby taxpayers borrow money, frequently by way of what is described as a margin loan, to buy shares.

Borrowing to buy shares in some ways is not dissimilar to the situation with borrowing to buy an investment property in as much as you can claim a deduction for the loan interest provided that it is reasonable to expect that assessable income will eventually flow from that investment. In other words, it doesn’t really matter if no dividends are received in the current year, so long as dividends can be expected to flow in future years. How distant that flow of future dividend income can be is a matter of some judgement, but provided that dividends are likely to flow at some stage in the next two to three years, there should be no problem. Beyond that, specialist advice should be sought.

The benefit of utilising such a strategy is that interest can be offset against any dividend income received, resulting in franking credits that can be offset against other income.

There are well known and well documented ways to finesse the situation such that if a taxpayer is on a higher marginal tax rate this year than is expected to be the case next year, the taxpayer could pre-pay 12 months interest in advance before year end and utilise the margin loan to maximise the current year tax deduction whilst the taxpayer is on that higher marginal tax rate.

Generally speaking, borrowing expenses such as establishment fees, legal expenses, and stamp duty on loans can also be claimed as expenses with some restrictions.

All this however, will be impacted if Labor is successful in its dual initiatives to restrict negative gearing and deny excess imputation credit refunds.

As I have written before, the negative gearing restrictions, if passed, whilst generally speaking, are only discussed in the context of property investments, will apply with equal rigor to share investments.

Investors juggling with either existing loans, or proposed loans, will need to take into account the fact that, if Labor is elected and can get their proposals passed:
Bob Deutsch, CTA
  • Any interest which exceeds the income from the shares will not be able to be offset against other income (eg salary income) and will need to be quarantined and carried forward for offset against future income from presumably the same or similar share or property investment. Exactly how broad that class will be against which interest can be offset remains open to some consideration.
  • Furthermore, any strategy designed to generate excess imputation credits for a low rate taxpayer, with the expectation that a refund of the excess imputation credit will be available, will need to be revisited with considerable urgency. Remember that if the taxpayer was entitled to an aged pension or part thereof as at 28 March 2018, there should be no problem in securing the excess imputation credit, but this will very much depend on the legislation that is ultimately drafted.
Whilst on that point, the whole question of the detail of the legislation will need to be examined with
great care, if and when it comes to pass, by taxpayers who have adopted such strategies.

Members, we welcome your thoughts via the TaxVineFeedback inbox.


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