14 Oct 2008
A general principle of tax law is that the onus of proof is on the taxpayer to prove deductions to which he/she is entitled.
This implies that the burden of proving that an amount of interest is tax deductible rests on the taxpayer. Furthermore, the taxpayer would have to justify the calculation of the amount claimed.
David Warneke, tax partner at Cameron & Prentice, says in the course of his tax practice he's had several occasions when it has not been easy for taxpayers to establish the amount of interest that is tax deductible.
"Take a relatively simple situation. Say that you own a house that you bought for R2m. 20% of the house is used as a home office."
"The current bond balance is R1,5m - it is an 'access bond'. Interest on the bond at a rate of 14% is currently R210k per annum. You would be entitled to claim 20% of R210k, or R42k, as a tax deduction in the production of your rental income.
"If you draw R100k on the bond to finance personal expenses, the bond balance will increase to R1,6m, with the interest thereon appearing on your monthly bond statement. However, the interest on the additional R100k is not tax deductible as it is not in the production of income.
"This portion of the interest therefore has to be excluded from the calculation of tax deductible interest for all years going forward. Therefore only 15/16 of the 20% of the interest that is reflected on the bond statement will be tax deductible from that point onwards. This percentage will obviously change if further withdrawals are made for non-income producing purposes."
He says a question that sometimes arises is whether the taxpayer can choose how to allocate an extraordinary receipt into the bond account.
"In the above example, say an inheritance of R400k is received. Can you allocate all of this to the 80 % private portion of the bond (and none to the 'home office'
portion), thereby leaving you with a larger income tax deduction going forward, or must it be pro-rated to both the private and 'home office' portions of the bond balance?"
"The fact is that you only have one borrowing - the bond, which is an undivided borrowing over the whole house. Therefore, once the inheritance is applied to the bond, it must reduce the borrowing over the whole house (pro-rata). You cannot choose to apply the inheritance to only a portion of the borrowing."
He says from the point of view of tax planning, it would therefore be better to apply the inheritance to any other non tax-deductible borrowing that you may have before paying it into the bond.
"Assuming that you are on the maximum marginal tax rate of 40% and that you are paying interest on your bond at the rate of 14% per annum, then the effective after tax return on money paid into the bond in the above example is 12,88 % - it is the full 14% on 80% of the bond plus (14%) on the remaining 20% of the bond, giving a result of 12,88%."
"If you have investments expected to yield an after tax return of more than 12,88% it would make sense to pay the inheritance into these investments rather than into the bond. If not, then paying it into the bond is the best solution," he concludes.
For more information contact David Warneke on 021 530 8444 or click here to visit the website.
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