Tax ruling offers 'nirvana'

A TAX ruling allowing investors to claim interest tax deductions on a loan they do not need to repay has been hailed as "nirvana" by a structured product marketer.

By InvestSMART · 2 Jul 2010

By InvestSMART ·
2 Jul 2010

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A TAX ruling allowing investors to claim interest tax deductions on a loan they do not need to repay has been hailed as "nirvana" by a structured product marketer.

The ruling for the controversial Macquarie Flexi 100 product gives investors certainty about claiming interest deductions on pre-paid interest up to a benchmark rate.

The structure of the "limited recourse" loan for 100 per cent of the investment means investors do not put their own money at risk.

They only pay for product fees and interest pre-payments, which are largely tax deductible, avoiding the trap of significant capital losses that occurred in tax-driven investments like Timbercorp and Great Southern.

The nature of the loan within the Macquarie product and others offered by UBS and Royal Bank of Scotland (RBS) has been challenged amid concerns the non-repayable loan is a "round-robin" device primarily structured for the tax benefit.

The Tax Office has identified that it does not like "round-robin" financing structures, limited recourse loans, bringing forward deductions for financing costs, and artificial reductions in risk exposure.

Despite the Macquarie Flexi 100 arguably containing those features, the Tax Office ruled on Wednesday in favour of the tax deductions.

A previous critic of the Macquarie Flexi 100, Tony Rumble, the founder of the structured product manufacturer Alpha Structured Investments, said the ruling was a "game changer". "Essentially the [Tax Office] has been very against people claiming tax deductions using round robin structures and also where there is no certainty to income being generated."

However, he said the ruling now confirmed tax deductibility for interest payments for Macquarie Flexi 100 with a limited recourse loan.

Justin Beeton, the managing director of JB Global, seized on the potential tax advantages for similar products he markets, writing to BusinessDay: "These investments are now the nirvana many investors have been searching for."

JB Global manufactures a white label RBS product based on shares of Berkshire Hathaway, which it has previously marketed as "the ultimate Warren Buffett investment".

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Frequently Asked Questions about this Article…

What did the Tax Office ruling say about interest tax deductions for the Macquarie Flexi 100?

The Tax Office ruled investors can claim interest tax deductions on pre-paid interest for the Macquarie Flexi 100, giving certainty that interest pre-payments up to a benchmark rate are tax deductible even where the loan is limited recourse and not repayable.

How does the Macquarie Flexi 100 product work and why does it matter to investors?

Macquarie Flexi 100 uses a limited recourse loan to provide 100% of the investment so investors don’t put their own capital at risk; they mainly pay product fees and pre-paid interest, which the ruling confirms are largely tax deductible, and this structure was designed to avoid the big capital losses seen in tax-driven schemes like Timbercorp and Great Southern.

What is a limited recourse loan and why is it important for tax deductibility?

A limited recourse loan is a financing structure where the borrower’s obligation is restricted to the investment’s assets rather than wider personal liability; in this case the Tax Office accepted that interest on such a loan for Macquarie Flexi 100 can be claimed as a tax deduction for pre-paid interest up to a benchmark rate.

What are ‘round-robin’ financing concerns and did the Tax Office address them?

‘Round-robin’ financing refers to arrangements designed mainly to generate tax benefits by circulating funds, and the Tax Office has said it does not favour round-robin structures, limited recourse loans used to bring forward deductions, or artificial reductions in risk exposure — yet in this ruling it still allowed the interest deductions for the Macquarie product.

Which other banks and products are mentioned as offering similar structures to Macquarie Flexi 100?

The article notes similar structured loan products have been offered by UBS and Royal Bank of Scotland (RBS); JB Global also manufactures a white-label RBS product based on Berkshire Hathaway shares that it has marketed as an ‘ultimate Warren Buffett investment.’

How have industry commentators reacted to the Tax Office ruling on these structured products?

Reactions were positive from some industry figures — Tony Rumble called the decision a ‘game changer’ confirming deductibility for interest payments on Macquarie Flexi 100, while Justin Beeton described these investments as the ‘nirvana’ many investors have sought because of the tax advantages.

What role does pre-paid interest and the benchmark rate play in claiming tax deductions?

Pre-paid interest refers to interest payments made in advance on the financing, and the ruling specifically gives investors certainty that pre-paid interest up to a benchmark rate can be claimed as a tax deduction for the Macquarie Flexi 100 product.

Does the ruling change the Tax Office’s view on bringing forward financing deductions and reduced risk exposure?

While the Tax Office has previously expressed opposition to bringing forward financing deductions, limited recourse loans and artificial reductions in risk exposure, the specific ruling for Macquarie Flexi 100 nonetheless allowed the claimed interest deductions, signalling an acceptance of the product’s tax treatment in this case.