A line of credit is simply a banking mechanism in which a bank customer has a loan amount pre-approved up to a specified amount. The line of credit can be set up to operate like a bank account.
Two Main Uses for a Line of Credit Account
One of the main reasons for establishing a line of credit is for carrying out investment activities. For example, an investor may want to invest in shares on the stock market over a certain period. With a secure source of funds available, the astute investor can take advantage of the investment opportunities when they arise.
A line of credit can also be convenient for personal use. Having a pre-approved source of funds available can iron out those sudden and unexpected requirements for cash. These can be paid on the credit card to earn reward points then paid off via the personal line of credit.
A personal line of credit can also be useful in managing funds for paying off a home mortgage.
Taxation Implications on Line of Credit Accounts
From an Australian taxation point of view, the interest allocation needs to be separated. That is, the Australian Tax Office needs to be able to clearly see that the interest being claimed as a tax deduction for investment can be proven that it is a direct result from earning an income.
If the interest on the cost for the purchase of a new boat are mixed up in the interest used for purchasing a share portfolio, the Australian Tax Office will be looking for a clear accounting process to show the two different interest allocations.
In many situations this can be extremely difficult as investment earnings may be coming both into the account and out of the account to purchase more income earning assets. And personal money may also be flowing in and out of the line of credit account.
If the Australian Tax Office can’t see the difference clearly, then they may reject the claim for the deductions of the interest using for income earning. This could be a significant amount of money.
In some situations, the taxpayer may have to repay previous year’s tax, or even a fine if the Australian Tax Office rules that the deduction claims for the interest on the income earning assets were not clearly allocated.
Splitting a Line of Credit
The simplest and easiest way to manage this situation is to establish two line of credit accounts when setting up this arrangement. One will be used solely for investment, while the other will be used exclusively for personal use.
There may be a slight cost involved in the extra line of credit account, but it may be well worth the extra cost to have the flexibility of the personal line of credit. And by having the two line of credit accounts, those valuable investment interest deductions will be protected.