Business liabilities 043-03090020

Item

Liabilities secured over both assessable assets and assets exempt from assessment

1

Example 1

A partner in a business offers his principal home (value $130,000) and a holiday home (value $90,000) as security for loans of $75,000 obtained in respect of a trucking business. The loans are secured by registered first mortgage on both the real estate properties.

Although not secured against business assets, under the modified application of section 1121(1) of the Social Security Act 1991, Effect of charge or encumbrances on value of assets to business liabilities, the amount of the loans would normally be deducted from the value of assets owned by the business. However, as the business loans are secured against both the customer's exempt principal residence and the assessable holiday home, section 1121(4), overrides this general rule. The amount of the loans for which the exempt principal home provides security cannot be deducted from the value of assets owned by the business.

In this situation, subsection 1121(4) of the Social Security Act 1991 provides for the amount of the business loans to be apportioned to determine the amount for which the holiday home provides security. It is only this amount (for which the holiday home provides security) that can then be deducted from the value of the assets owned by the business.

Of the total secured liabilities of $75,000, the amount of the loan for which the holiday home provides security can be calculated as follows:

$75,000 (amount of the loan) x $90,000 (value of the assessable assets)

$130,000 + $90,000 (value of all assets providing security)

= $75,000 x $90,000 divided by $220,000

= $75,000 x 0.40909

= $30,681

The amount of $30,681 is therefore the proportion of the secured liability of $75,000 which can be deducted from the value of the holiday home.

The proportion of the loans for which the customer's principal home provides security is therefore $44,319 ($75,000 - $30,681). As the principal home is exempt from assessment, the amount of the loans for which the customer's home provides security are effectively not taken into account when determining the value of the customer's total assessable assets.

Note: although the amount of the liability secured against an asset exempt from assessment cannot be deducted from the value of assets owned by the business, interest expense incurred in respect of the liability is an allowable deduction against business income if the loan has been taken out for business purposes.

Liabilities of private trusts and companies are treated differently to this example.

2

Example 2

Primary production

A customer is a single age pension claimant who is involved in a primary production partnership with the customer's son. The customer owns a farm property which is run by the partnership but not listed as a partnership asset. The customer lives on the property.

The value of the farm is:

• Total property (mixed asset): $450,000
• House and curtilage: $150,000
• Mortgage over whole farm property $240,000

The partnership has a liability in respect of debts secured against the farm property (including the home and curtilage). The liability to the bank should be regarded as being only a partial primary production liability unless the bank has specified the security is over a specific part of the land that does not include the home and curtilage, or the customer has advised the encumbrance is entirely related to the purchase of primary production assets.

To determine the net asset value of the primary production asset, the portion of the whole mortgage which is attributable to the primary production asset must be determined:

• First, determine the value of the primary production asset. This is the value of the whole property (mixed asset) less the value of the house and curtilage: $450,0000 - $150,000 = $300,000
• Next, determine the portion of the mortgage which is attributable to the primary production asset. This is the value of the primary production asset multiplied by the value of the whole mortgage, divided by the value of the whole property (mixed asset): ($300,000 x $240,000) ÷ $450,000 = $160,000
• Finally, determine the net assessable value of the primary production asset. This is the value of the primary production asset less the portion of the mortgage which is attributable to the primary production asset: $300,000 - $160,000 = $140,000

Under the provisions of section 1121A of the Social Security Act 1991, the customer's share of a deficiency in the value of the farm partnership is treated as a primary production liability. Accordingly, the amount of this deficiency applicable to the customer is allowed as a deduction against the assessable value of the farm land (primary production asset).