A margin loan is a loan an investor takes out to invest in shares or managed funds. Financial institutions offer margin loans over a variety of assets including shares, listed securities and unlisted managed funds. Typically, an investor will borrow a certain amount of money and contribute an amount to invest in their portfolio. While a margin loan can potentially magnify any potential losses or gains, it can assist investors in diversifying their portfolio.
Generally a margin lender will be prepared to loan funds up to the ‘market based limit’ of the underlying assets over which the margin loan is secured. Each underlying asset has a gearing ratio assigned to it by the lender, which indicates the percentage of the market value of the asset up to which the lender will loan funds. The ‘market based limit’ is calculated as the sum of each of the individual asset lending limits attributable to assets the investor pledges as security for the margin loan.
Falls in the market value of an investor’s portfolio, or a reduction by the lender in the gearing ratio of one or more particular assets, can cause the market based limit to be lower than the outstanding amount of an investor’s margin loan. A margin call may occur when this happens.
In this case, the margin lender may ask the investor to contribute more funds into their account to reduce the loan balance, contribute additional securities to their account, increase their market based limit, or sell down securities and use the sale proceeds to reduce the margin loan balance.
In the case of a margin call, the margin lender will notify the investor of the amount and timing of the contribution that needs to be made so that their loan is less than their market based limit.
The investor has beneficial ownership of any assets purchased through a margin loan.
All assets purchased through a margin lending facility are held directly in the investor’s name so that the investor directly receives any dividends and distributions.
The interest paid will generally be tax deductible where an investor incurs the expense in gaining or producing assessable dividend and/or distribution income.
The amount of interest which is deductible depends on the individual circumstances of an investor and it is recommended that an investor seek independent taxation advice.
Where the investor’s margin loan is jointly held across two or more portfolio accounts with us, we will equally split the margin loan interest across those accounts. We recommend that investors seek independent taxation advice in order to assess whether or not this split is correct and make the appropriate amendments where required.
Investors may prepay interest on a margin loan in advance. This may allow some investors, such as non-business individuals, to not only lock in the interest they pay for the forthcoming income year but also to potentially claim an upfront tax deduction for the amount of the prepayment.
For other entities, such as companies, they may only be entitled to a deduction in respect of the period to which the payment relates.
Where an investor cancels their margin loan, the margin lender may decide to refund any amounts of prepaid interest not yet incurred. If this occurs, the investor must declare the amount of any interest refunded as assessable income in the year in which they receive the refund.
Where an Australian resident receives distributions which are non-assessable for tax purposes, the amount of interest incurred on a margin loan may not be fully deductible. This is because the interest must be incurred in gaining or producing assessable income. Distributions which may fall into this scenario include tax free, tax deferred or return of capital amounts.
Where this is the case, for the purposes of claiming a deduction, the investor may have to apportion the amount of interest incurred between the assessable and the non-assessable portion of the distribution.
A non-resident can only claim the interest expense on a margin loan as a deduction to the extent that the non-resident derives assessable income. A non-resident is only assessable on Australian other income and Taxable Australian Real Property (TARP) capital gains. All other forms of income a non-resident receives is either non-assessable (eg foreign income and non-TARP capital gains) or exempt income (eg interest and unfranked dividends).
A non-resident can therefore only claim that portion of their interest expense which relates to Australian other income and TARP capital gains.
We report on margin loans in the following manner:
- any income derived from assets in a margin loan account is disclosed as assessable income in the Tax Report – Summary and the Tax Report – Detailed
- any interest expense incurred is also disclosed in both the Tax Report – Summary and the Tax Report – Detailed in the Fees and Expenses section of those reports. The amount of interest expense incurred is disclosed as deductible.
Where an investor has closed out their margin loan and received an interest refund from the margin lender, the amount of interest refunded is disclosed as assessable income on both the Tax Report – Summary and the Tax Report – Detailed.
Where an investor has changed margin lenders throughout the year, we only report the amounts as provided by their margin lender at 30 June. Investors will need to add any other information received from prior margin lenders to the information disclosed on their annual Tax Report – Summary and Tax Report – Detailed.
The above mentioned treatment does not take into account an investor’s specific circumstances and we recommend that independent taxation advice be sought in relation to the appropriate treatment for tax purposes.