Interest Deductions when Onlending Loans

A recent tax case at the Taxation Review Authority has highlighted the need to ensure funds are borrowed in the correct manner so that the interest can be claimed as a tax deduction against income.

The case related to a taxpayer that borrowed money from the bank under company A (an LAQC) which then onlent that money to company B for the purchase of a farm.  There was never any interest demanded on the loan between company A and company B.  Company A claimed the interest it paid to the bank but the IRD argued is wasn't allowed to.

The IRD won this case.  It was decided that company A was not entitled to claim the interest as a tax deduction as the interest was not incurred in derived income (ie no interest income was received on the funds onlent to Company B).

This case is relevant for property investors in at least the following common situations:

Situation 1:  A deposit on a rental property owned by a look-through company (LTC) or trust is paid from a personal loan facility.

In this situation, there are 4 important things to do:

  • Ensure the personal loan is kept separate from other personal loans so the attributable interest can be calculated 
  • Ensure that the LTC or trust actually pays the interest or reimburses that same amount
  • Have a loan agreement drawn up that acknowledges the loan amount and states that interest will be charged at the bank interest rate
  • Consider withholding tax implications if the total interest amount is more than $5,000 a year

Situation 2:  Your trust owns your personal home and the associated loan is under your personal name and you then decide to rent out the home.

In this situation, there are 4 important things to do:

  • Ideally, the loan should be transferred to the trust as a repayment of your beneficiary loan account (there may be issues to consider if you have completed your gifting programme)
  • Ensure that the trust actually pays the interest or reimburses you that same amount
  • Have a loan agreement drawn up that acknowledges the loan amount and states that interest will be charged at the bank interest rate
  • Consider withholding tax implications if the total interest amount of more than $5,000 a year

Disclaimer: The above article is general in nature and we recommend you seek professional advice tailored to your specific personal situation.