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How to calculate deductions for a capital protected borrowing

Work out how to calculate any deductions you can claim if you use a capital protected product or borrowing.

Last updated 29 June 2023

Work out which treatment applies

The way a capital protected product or borrowing is treated for tax purposes depends on:

  • whether a product ruling applies to it
  • the date the arrangement was entered into or extended
  • whether it provides capital protection by way of a limited recourse loan only, or another method.

To work out which treatment applies to your product follow the following steps.

Step 1 – Does a product ruling cover the arrangement?

Step 2 – Was the capital protected product or borrowing entered into or extended before 9:30 am on 16 April 2003?

Step 3 – Was the capital protected product or borrowing entered into or extended on or after 9:30 am on 16 April 2003 but before 1 July 2007?

Step 4 – Was the capital protected product or borrowing entered into or extended on or after 1 July 2007 but before 13 May 2008?

Step 5 – The capital protected product or borrowing was entered into or extended on or after 13 May 2008 – go to Entered into or extended on or after 13 May 2008.

Covered by a product ruling

You can search our legal database for a product ruling on your particular capital protected product or borrowing.

The issue and withdrawal dates of the rulings affect the way they are applied to your arrangement. Some rulings have been withdrawn but are still relevant to arrangements that were entered into before they were withdrawn.

If you have invested in a product that is covered by a product ruling, refer to that ruling to determine the tax treatment that applies.

The fact that you hold a product covered by a product ruling does not conclusively determine that the ruling applies to you. Read the ruling to confirm that the:

  • product you hold and the circumstances in which you hold it are in fact covered by the ruling
  • date you entered into the arrangement makes the ruling relevant to your circumstances.

Read the ruling to confirm whether it is subject to, or has been subject to, amendment to give effect to changes to the benchmark interest rate applicable to your capital protected borrowing.

Start of example

Example – covered by a product ruling

Product Ruling PR 2008/50 was published on 21 May 2008. It provides the Commissioner's opinion on the amount that may be deducted for a capital protected borrowing arrangement to be entered into after 13 May 2008.

As this product ruling was published after the announcement of the new benchmark rate, the ATO took the approach that a legally binding ruling could not be given that enforced the new benchmark rate.

It was therefore the investors' choice to either:

  • self assess using the proposed benchmark interest rate
  • use the existing benchmark interest rate and amend their tax returns once Royal Assent was received.

Jon, an investor, decided to use the old benchmark interest rate, as addressed in the product ruling, and paid interest on the investment at 12%, which equalled $100 for the period. At that time, the RBA's variable interest rate for personal unsecured loans was 14%, so the interest paid was entirely below the benchmark interest rate and the full $100 interest payment was deductible.

However, once the change to the benchmark interest rate received royal assent, the product ruling PR 2008/50 was amended and as Jon self assessed using the old benchmark interest rate, he was required to amend his tax returns.

For the period in question, the RBA's variable housing rate plus 100 points was 10%. Therefore, the investment interest rate of 12% was now above the benchmark interest rate. This means that 2% was no longer deductible. Jon had to amend his tax returns by 29 June 2013 to disallow approximately $14 interest.

End of example

Entered into before 9:30 am on 16 April 2003

When interest is fully deductible

Based on the decision in Firth v. Federal Commissioner of Taxation, if you entered into your product before 9:30 am on 16 April 2003, interest is fully deductible on products entered into before 9:30 am on 16 April 2003 if both of the following apply:

  • The capital protection is only provided by way of a limited recourse loan facility.
  • The loan does not separately identify or attach value to the capital protection component.

For information on the treatment of capital protected products without a separately identifiable 'put option' entered into before 16 April 2003, see ATO Interpretative Decision ATO ID 2003/674.

Other products

For products that use other methods of capital protection, the tax implications will depend on the specific terms and conditions of the capital protected product. If you need information on capital protected products acquired before 9:30 am on 16 April 2003 that are not covered by a product ruling and provide capital protection other than by way of limited recourse loans, you can request a private ruling to gain certainty.

Entered into or extended on or after 9:30 am on 16 April 2003 but before 1 July 2007

If you entered into or extended a product on or after 9:30 am on 16 April 2003 but before 1 July 2007, part of the interest cost is attributed to the capital protection feature of the loan and is not deductible.

Products with an explicit put option

If you have a capital protected product – such as instalment warrants traded on the Australian Securities Exchange (ASX) – that contain an explicit put option that gives you the right to 'put' or sell the underlying share, unit or stapled security ('underlying security') back to the lender for the higher of the market value or the amount outstanding under the loan, in the case of a purchase in the:

  • primary market (before listing on the ASX), the cost of the capital protection component is the amount that is paid for the put option
  • secondary market (once listed on the ASX), if the market value of the underlying security at the time of purchase is
    • greater than the loan amount, the amount attributed to the cost of the capital protection component is the price of the instalment warrant plus the loan amount less the sum of the market value of the underlying security and the interest prepaid on the newly acquired loan
    • equal to or less than the loan amount, the amount attributed to the cost of the capital protection component is the price of the instalment warrant less the interest prepaid on the newly acquired loan.
     

Other capital protected products

For other capital protected products the cost of the capital protection component is the greater of the:

  • difference between the total amount, ignoring amounts that are not in substance for capital protection or interest, incurred by the borrower in respect of the borrowing and the amount determined by applying the Reserve Bank of Australia's indicator rate for personal unsecured loans (fixed or variable rate, whichever is applicable to the same amount of borrowing)
  • amount determined by reference to the following specified percentage amounts of the expense on a capital protected product
    • 40% for a product with a term of one year or shorter
    • 27.5% for a product with a term longer than one year but not longer than 2 years
    • 20% for a product with a term longer than 2 years but not longer than 3 years
    • 17.5% for a product with a term longer than 3 years but not longer than 4 years
    • 15% for a product with a term longer than 4 years.
     

Capital protected products entered into or extended before 1 July 2007 and still in existence at 13 May 2008 may continue to use the methodology outlined above until 30 June 2013 or the end of the life of the arrangement, whichever is sooner.

Entered into or extended on or after 1 July 2007 but before 13 May 2008

For capital protected products entered into on or after 1 July 2007, you calculate the amount that is reasonably attributable to capital protection using 3 steps.

Step 1 is to calculate the total costs incurred by the borrower under, or in respect of, the capital protected product for the income year, ignoring amounts that are not in substance for capital protection or interest.

Step 2 is to apply the RBA's indicator variable interest rate for personal unsecured loans to the same amount of borrowing. If the borrowing is at a:

  • fixed rate you would apply the indicator variable interest rate at the time the first of the amounts in Step 1 was incurred
  • variable rate, you would apply the average of the indicator rates – table F5External Link during the term of the borrowing.

Step 3 is applied if the amount under Step 1 exceeds the amount under Step 2. In this case, the excess is attributed to the capital protection for the income year. If the underlying securities you purchased under the capital protected borrowing are held on capital account, the excess would be a capital cost and would not be deductible.

Capital protected products entered into or extended after 1 July 2007 but before 13 May 2008 and still in existence at 13 May 2008 may continue to use the RBA's indicator variable interest rate for personal unsecured loans until 30 June 2013 or the end of the life of the arrangement, whichever is sooner.

Entered into or extended on or after 13 May 2008

For capital protected products entered into on or after 13 May 2008, the amount that you can reasonably attribute to capital protection is calculated using 3 steps.

Step 1 is to calculate the total costs incurred by the borrower under, or in respect of, the capital protected product for the income year, ignoring amounts that are not in substance for capital protection or interest.

Step 2 is to apply the benchmark rate, being the RBA's standard variable housing rate plus 100 points to the same amount of borrowing. If the borrowing is at a:

  • fixed rate you would apply the indicator variable interest rate at the time the first of the amounts in Step 1 was incurred
  • at a variable rate, you would apply the average of the indicator rates – table F5External Link during the term of the borrowing.

Step 3 applies if the amount under Step 1 exceeds the amount under Step 2. In this case, the excess is attributed to the capital protection for the income year. If the underlying securities you purchased under the capital protected borrowing are held on capital account, the excess would be a capital cost and would not deductible.

If as a result of the change to the benchmark rate you were required to amend your tax returns, you only had until 29 June 2013 to do so.

Start of example

Example – Entered into or extended on or after 13 May 2008

Hailey, an investor, decided to invest in a share portfolio using a loan with a capital protection feature in July 2011. The loan itself had an interest rate of 15%. The RBA website provided a standard variable housing interest rate of 7.8%. With the additional 100 points, the benchmark interest rate became 8.8%. This means that 6.2% of the interest is treated as a put option. Therefore, at the end of the 2011–12 financial year Hailey will prepare her tax return using the following steps:

Step 1: Hailey calculates total interest expenses for the investment as $1,000.

Step 2: Applying the benchmark rate to the same amount of borrowing provides an amount of $560.

Step 3: As the amount under step 1 exceeds the amount under step 2, the excess $440 is attributed to the cost of capital protection, and – assuming the securities are held on capital account – is not deductible.

End of example

For changes to the benchmark lending rate to be used after 13 May 2008, see Capital protected products and borrowings.

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