• 8.8 Reduction in taxable value where interest would have been deductible to employee

    The taxable value of a loan fringe benefit may be reduced in accordance with the 'otherwise deductible' rule, but only if the recipient of the benefit is the employee (that is, a loan provided to an associate is not eligible for this reduction). Broadly, this means that the taxable value may be reduced to the extent to which interest payable on the loan is, or would be, allowable as an income tax deduction to the employee. For example, if an employee were to use a loan from you wholly to purchase interest-bearing investments, any interest payable on the loan would be wholly deductible for income tax purposes. So under the otherwise deductible rule, the taxable value of this loan fringe benefit would be nil, regardless of whether you charged a low, or even a nil, rate of interest on the loan.

    Special rules apply where the interest that would have been deductible to the employee is incurred in relation to a car (refer to section 8.10).

    Applying the otherwise deductible rule produces different results depending on whether any interest charged was intended to be for any private element of the loan fringe benefit. This is because the employee is entitled to an income tax deduction for interest charged on the portion of the loan used to derive their assessable income, but not for interest charged on the portion of the loan used for private or domestic purposes.

    Therefore, where the otherwise deductible rule applies, the taxable value of a loan fringe benefit is:

    • the interest that would have accrued during the FBT year if the statutory interest rate had applied to the outstanding daily balance of the loan, reduced by
    • any interest that actually accrued - this result is then further reduced by
    • the otherwise deductible amount.

    You can calculate the taxable value of a loan fringe benefit where the otherwise deductible rule applies using the following steps:

    Step

    Action

    1

    Calculate the taxable value of the loan fringe benefit ignoring the otherwise deductible rule.

    2

    Ignore any interest you charged on the loan and calculate the taxable value of the loan fringe benefit as if the loan was interest-free.

    3

    Now suppose that the employee had paid interest equal to the amount of the taxable value as calculated in step 2. How much of this hypothetical interest payment would have been income tax deductible to the employee?

    4

    Now look at the real loan situation. If the employee is being charged interest on the loan, how much of this interest is allowable as an income tax deduction to the employee?

    5

    Subtract the actual deductible amount (step 4) from the hypothetical deductible amount (step 3). The result is the amount you can deduct from the taxable value of the fringe benefit.

    6

    The taxable value is your result from step 1 minus your result from step 5.

    Example: rate set without regard to employee's use of loan
    On 1 April 2008, an employee is given a loan of $50,000 at 5% for the whole of the FBT year. No repayments of principal are required in that year. The 5% rate is set without regard to how the employee intends to use the loan. The employee applies 60% of the loan to interest-bearing investments and spends the remaining 40% on home improvements.

    The statutory interest rate is 9.00%.

    The taxable value is calculated as follows:

    Step

    Action

    Result

    1

    Calculate the taxable value of the loan fringe benefit without the otherwise deductible rule.

    That is:
    (Amount of loan x statutory interest rate) - (Amount of loan x actual interest rate charged)

    ($50,000 x 9.00%) - ($50,000 x 5%)

    $4,500 - $2,500
    = $2,000

    2

    Ignore any interest charged on the loan and calculate the taxable value of the loan benefit as if the loan was interest-free.

    $50,000 x 9.00%
    =$4,500

    3

    Now suppose that the employee had paid interest equal to the amount of the taxable value calculated in step 2. How much of this hypothetical interest payment would have been income tax deductible to the employee?

    $4,500 x 60%
    = $2,700

    4

    Now look at the real loan situation. If the employee is being charged interest on the loan, how much of this interest is allowable as an income tax deduction to the employee?

    $2,500 x 60%
    = $1,500

    5

    Subtract the actual deductible amount (step 4) from the hypothetical deductible amount (step 3). The result is the amount by which the taxable value of the fringe benefit may be reduced.

    $2,700 - $1,500
    = $1,200

    6

    The taxable value is the result from step 1 minus the result from step 5.

    $2,000 - $1,200
    = $800

    Example: rate set with regard to employee's use of loan
    On 1 April 2008, an employee is given a loan of $50,000 at 5% for the whole of the FBT year. No repayments of principal are required in that year. The employee intends to use 50% of the loan for interest-bearing investments and spend the remaining 50% on home improvements.

    The statutory interest rate was 9.00%.

    The 5% interest rate is set by the employer after considering how the employee intends to use the loan (that is, the employer knows that under the otherwise deductible rule there will be no FBT liability for that part of the loan used to produce income. Therefore, the employer charges interest at a rate sufficient to avoid incurring FBT on that part of the loan used for private or domestic purposes).

    By the time the employee actually obtains the loan funds, the interest-bearing investments have increased in price and eventually cost 60% of the funds, so only 40% of the funds are spent on home improvements.

    The taxable value is calculated as follows.

    Step

    Action

    Result

    1

    Calculate the taxable value of the loan fringe benefit without the otherwise deductible rule.

    That is:
    (Amount of loan x statutory interest rate) - (Amount of loan x actual interest rate charged)

    ($50,000 x 9.00%) - ($50,000 x 5%)

    $4,500 - $2,500
    = $2,000

    2

    Ignore any interest charged on the loan and calculate the taxable value of the loan benefit as if the loan was interest -free.

    $50,000 x 9.00%
    = $4,500

    3

    Now suppose that the employee had paid interest equal to the amount of the taxable value calculated in step 2. How much of this hypothetical interest payment would have been income tax deductible to the employee?

    $4,500 x 60% business use
    = $2,700

    4

    Now look at the real loan situation. If the employee is being charged interest on the loan, how much of this interest is allowable as an income tax deduction to the employee?

    If the employer had not made allowance for the intended use of the loan, they would have charged interest at the statutory rate of 9.00%.

    However, because the employer reduced the interest rate to take into account the intended business use and the effect of the otherwise deductible rule, the employee's income tax deduction is limited to:

    • the amount that would have been allowed as a deduction to the employee if no allowance had been made for the income-producing purpose for which some of the loan funds were to be used, reduced by
    • the amount of the allowance that was made.

    $50,000 x 9.00% interest rate x 60% business use. The employee would have been entitled to a deduction of:

    $4,500 interest x 60% business use
    = $2,700

    = ($50,000 x 9.00% x 60%) - ($50,000 x 9.00% x 50%)

    =$2,700 - $2,250

    = $450

    5

    Subtract the actual deductible amount (step 4) from the hypothetical deductible amount (step 3). The result is the amount by which the taxable value of the fringe benefit may be reduced.

    $2,700 - $450
    = $2,250

    6

    The taxable value is the result from step 1 minus the result from step 5.

    $2,000 - $2,250
    = 0

    Attention

    There can be no negative figures.

    End of attention
      Last modified: 03 Jul 2012QC 17821