Beneficial ownership: Saving through the other deductible rule
The Other Deductible Rule can save you time and money by allowing you to pay for expenses directly from your business' earnings. This article discusses the differences between legal control and beneficial ownership.
The Other Deductible Rule is a real paperwork saver. Instead of having to pay yourself and then pay for expenses you’d then claim personally in your own tax return, all you do is pay it directly out of your business/company.
That way rather than you having to personally record it as an expense, the business does instead. This saves you the extra hassle of tracking personal expenses.
In order to understand the concept behind this, it is first necessary to define these two terms:
- Legal Control
- Beneficial Ownership
Legal control is legal title only. A person with legal control can buy and sell an asset but will never own or enjoy the benefits of ownership (such as income or usage).
Beneficial ownership on the other hand allows a person to enjoy the benefits of ownership (including; usage, income, profits etc) even though legal title is in another name.
Incidentally, this is how a trust works; it is simply an agreement between two parties. A trust separates control and ownership.
"Many people believe that a loan document needs to be in the person’s name so they are entitled to the interest as a tax deduction. This, however, is a myth!"
Many people believe that a loan document needs to be in the person’s name so they are entitled to the interest as a tax deduction. This, however, is a myth!
In the case of a loan one may have legal control by having their name on the loan but somebody else might have Beneficial Ownership. This means that the beneficial owner is the one who can claim the tax benefits of the investment loan, the legal owner cannot. Here’s an example:
John helps his son, Toby, buy an investment property. The loan is in John’s name but Toby is paying the mortgage. In this case Toby is the beneficial owner of the property; he is the one who will receive the negative gearing benefits. John simply has legal title and doesn’t receive any income or ownership benefits at all.
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Separating control and ownership can be as simple as a handshake or as detailed as a trust deed. The methods used each have their advantages and disadvantages.
Another popular myth is that if an asset is simply put in someone else’s name then it’s protected, however this is not always the case. In an effort to avoid losing their assets while going through litigation, some people have allowed others to take legal control while they maintain beneficial ownership.
We know of one lady who didn’t want an investment property in her own name for this very reason. However, we pointed out that if the courts proved she was the beneficial owner, by way of bank account transactions (i.e. she was paying the loan) then the courts could claim her asset anyway. Asset protection and estate planning require much more than simply putting it in someone else’s name.
On a more positive note, separating ownership and control can be beneficial when buyer’s discretion is an issue and the purchaser wishes to remain unknown. For example, you might not want your neighbours to know that you are the one buying their house!
In summary, the name on the loan document states who has legal control, which can be an individual or a company.
On the other hand, the beneficial owner, (the one who is entitled to the income and tax benefits) is most likely not even mentioned on the loan document and may be somebody else entirely!
The ATO recognises this with their “Other Deductible Rule” which simply states that if it’s deductible to the company or vice versa than its deductible to the individual and vice versa.
The thinking behind this is If John paid the interest because the loan was in his name but he was reimbursed by Toby as it is Toby’s loan (beneficial owner of the loan, i.e Toby, is required to pay the interest) than John’s net effect is nil (i.e. he pays $10 to the bank but receives $10 from Toby). Toby’s net effect is $10 paid in interest and hence he receives a tax deduction of $10. Remember the loan was in John’s name.
When assessing all the above, the name on the loan document is totally irrelevant as long as you can prove who the beneficial owner of the loan is as opposed to the legal owner.
There are certain documents and steps that need to be taken to ensure the ATO is happy but as long as these steps are taken the name on the loan is totally irrelevant.
This concept applies to the soloist also. As a business owner it is not necessary for you to receive the money. Instead, use the “other deductible rule” and pay the expense directly, instead of paying yourself and then paying the expense, such as a negatively geared property.