Is your redraw facility wasting tax deductions?

Different structures produce different tax results. So it is with bank loans. Different tax outcomes may arise from using a redraw facility on your loan compared to an offset facility.  Both facilities aim to help you manage cash flow and minimise interest on your loans, but often they produce different tax outcomes.

What’s the difference between a redraw facility and an offset facility?

If your loan has a redraw facility you can deposit money into the loan to reduce the loan balance and then redraw the money later if needed. The temporary reduction in the loan balance reduces the amount of interest you pay to the bank on your loan. Similarly but different – an offset facility is a separate bank account that is linked to the loan account.  Deposits are made into the offset account, and the combined total of the loan balance less the offset account is used to calculate interest charges. Both enable deposits to be made to reduce the overall loan balance and thereby reduce interest costs and both enable the money deposited to be withdrawn later.

The difference is claiming a tax deduction for interest payments. A tax deduction is available for an interest expense if the interest expense is incurred in connection with earning income.  It helps to ask yourself – what was the use of the borrowed money? Was it to acquire a property to earn rent?  In this case, an interest deduction can be claimed on the interest. There is no tax deduction if the money was used for private purposes.  For example, a private purpose could be buying a home, paying personal taxes, or travelling overseas for a holiday. There is no tax deduction for these private uses of borrowed money. 

A tax deduction for interest requires the borrowed funds to be used in connection with earning income.

Let’s apply that rule to offset accounts and redraw facilities.  As an example say you have borrowed $1million to acquire a property to earn income from rent.   Separately, you have sold a property and you know that you have a $500,000 tax bill that will be due for payment in 12 months.  You decide to use the $500,000 to reduce your loan balance for 12 months until the money is needed to pay the tax. This will reduce the interest you pay.

If you have a redraw facility, you pay $500,000 directly off the loan balance, and then redraw the money in 12 months.  When you redraw the money, you need to again ask the question – what is the money used for?  The answer is to pay a personal tax bill, which is a private use  - insufficiently connected with income earning activities – and therefore there is no tax deduction for the interest expense on the $500,000.  The purpose of your $1million loan has now changed to being 50% for acquiring the rental property and 50% for paying a personal tax bill.  As a consequence, a tax deduction can only be claimed for 50% of the interest you pay the bank, because now only half of the loan is used in connection with earning income.

What about the offset facility?

Using the same example of a $1million rental property loan, the $500,000 is paid into the offset account, and the $1million loan account is untouched. The offset facility interest is calculated on the combined balance of the loan account and the offset account, so for 12 months the interest expense is reduced. Then when the time comes, $500,000 is withdrawn from the offset account to pay the tax. The loan account is untouched and the purpose of the rental property loan has not changed at all, so a tax deduction is available for 100% of the interest expense on the loan.  The offset facility has a different tax outcome because the offset facility is a separate bank account and the use of the money from the loan account does not change.

If someone wants to access these loan management mechanisms what should they do?

It’s important to have your eyes open to the tax consequences of your financial choices. Banks do not provide the same financial products, some allow offset accounts for trusts and companies as well as individuals, and other banks only offer it to individuals.  You also need to be aware of fees for having these accounts, comparative interest rates and rules for deposits and withdrawals.

It is well worth while having a meaningful conversation with your accountant first on these matters, so when you go to the bank you can ask the right questions and pay attention to the detail.

For more information on determining the right structure for your specific needs or to discuss how to best maximise your tax deductions please speak with your usual Mazars advisor or one of our specialists via the form below.

Author: Michael Jones

Updated: 15/11/2023

Published: 10/11/2021

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