From time to time the ATO expresses its opinion on how certain tax laws should be interpreted.
In April this year the ATO released its opinion in Taxation Determination TD 2017/11 on the taxation of bank account interest.
The ATO focused on two areas:
- bank accounts in children’s names, and
- bank accounts in two or more names i.e. ‘joint accounts’.
While the answer to the question of who pays income tax on bank account interest may seem unequivocally clear — the account holders — in some situations the answer is not straightforward. Could, for example, the interest credited to an account held in two names be attributed entirely to the account holder falling in the lower tax bracket such as a child or stay-at-home spouse?
In order to determine who is liable for income tax on bank account interest, the ATO suggests we look beyond those merely named as account holders:
“for income tax purposes, interest income on a bank account is assessable to the person or persons who beneficially own the money in the account.”
The ATO will therefore seek to identify the real or ‘beneficial owners’ of the account, that is, the parties who enjoyed the benefits associated with the account, such as access to transaction-enabling facilities, secure storage of funds, and the source and use of the funds which passed through the account. That is not to say the ATO will disregard the identity of account holders, rather the ATO will consider factors in addition to strict legal title in order to determine who received the benefits of ownership. That is, the beneficial owner of a bank account may be a different party to the party named as the account holder or legal owner.
Consider two scenarios where a bank account is opened in a child’s name: one where the child is the beneficial owner and one where the child is not.
Example 1 – account holder is beneficial owner
Five year-old Edwina has an account in her own name which was opened by her mother, Zelda. Because of Edwina’s age, the bank requires Zelda to act as trustee over the account. Following the example set by her mother, Edwina is determined to build for herself a financial nest egg. This year, all of Edwina’s birthday money was deposited into the account. The bank has credited the account with $500 interest.
Despite being the only signatory to the account, Zelda has not deposited any of her own money into the account and has not used the funds in the account for her own purposes. Edwina is therefore the beneficial owner of the account and the interest income will form part of Edwina’s taxable income in the year in which the interest was credited.
At first glance this appears to allow Edwina to benefit of the $18,200 tax free threshold. Mindful that parents might exploit such an arrangement by channelling funds into children’s accounts, the government introduced anti-tax avoidance provisions that target interest income attributable to minors. The effect is that any interest attributable to Edwina, in excess of $416, will be taxed not at Edwina’s otherwise applicable marginal rate but at a special rate, as high as 66%.
Edwina must report $84 ($500 less $416) on her personal tax return as ‘eligible taxable income’. Note that despite being the account’s trustee, Zelda need not lodge a trust tax return in relation to the interest income derived from the account.
Example 2 – account holder is not beneficial owner
Fourteen year-old Freja has an account in her name which was opened by her father, Walter. Walter and Freja are both signatories to the account, but only Walter makes regular deposits and withdrawals, essentially to manage household expenses. This year the bank credited the account with $200 interest.
Under this scenario, Walter operates the account as if it were his own. Walter is therefore the beneficial owner of the account. Walter must include the interest credited to the account in his personal tax return in the year in which the interest was credited. The interest will be taxed at the marginal tax rates applicable to Walter.
Where an account is jointly held by two or more parties, the ATO presumes that any interest income credited to the account is attributable to the account holders in equal shares..
By applying the concept of beneficial ownership, the presumption may in some circumstances be rebutted. The ATO has determined that evidence in support of such a rebuttal can include ‘information regarding who contributed to the account, in what proportions contributions were made, the nature of the contributions, who drew on the account and who used the money (and accrued interest) as their own property. Evidence may also be provided that joint account holders hold money in the account on trust for other persons’.
Consider, for example, the situation where Nancy, an elderly nursing home resident, is the joint holder of a bank account with her nephew, Sid. Because of Nancy’s lack of mobility, Sid performs transactions on the account on Nancy’s behalf, depositing cheques payable to Nancy over-the-counter and making ATM withdrawals to provide Nancy with cash. Sid makes no use of the funds in the account for his own purposes, nor does he deposit his own funds into the account. Nancy is therefore the beneficial owner of the account.
Because Sid has no beneficial ownership of the funds on deposit, Nancy must declare all of the interest income credited to the account in her personal income tax return. The interest income will be taxed at the ordinary marginal rates applicable to Nancy.
Characterising an arrangement involving multiple parties as endowing one party with all of the benefits, and the others with none may not always be correct. To the extent that the benefits are divided among multiple beneficiaries, a degree of apportionment may be appropriate.
While ATO rulings are not legally binding on taxpayers, they give an indication of the kind of response taxpayers can expect from the ATO, particularly where bank account interest is excluded from a bank account holder’s income tax return.