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This case concerns whether certain interest paid on a bank loan that was claimed to be used to replace one of the two original mortgage loans taken out by the taxpayer can be regarded as "home loan interest" (i.e. interest paid by a person on a loan obtained to purchase a residential property that is used by the person exclusively or partly as his place of residence) under section 26E of the Inland Revenue Ordinance and therefore qualifies for the deduction of home loan interest for salaries tax purposes. The Board accepted the evidence presented by the taxpayer and held that the second bank loan in question was in substance taken out to replace an original loan of a similar amount borrowed by the taxpayer for the acquisition of his place of residence.
The facts
The taxpayer and her husband purchased a property from a government organisation in July 1999. The purchase was financed by two mortgages. The first mortgage was taken out with a bank whereas the second mortgage was made available by the government organisation (the "government loan"). The government loan in the total amount of HK$467,600 was repaid by the couple in July 2004. At the same time, the couple made an application to the government organisation for an assessment of premium to release them from a restriction against alienation over the property. The couple was later informed of the premium assessed in the amount of HK$641,000. In September 2004, the couple obtained a second loan from the same bank and used the loan to (1) repay the outstanding portion of the first bank loan in the amount of around HK$488,940 and (2) settle the premium payable to the government organisation.
There is no dispute that the part of the second bank loan used in (1) falls within the definition of "home loan" and the interest paid on that part of the loan can be deducted as home loan interest. The issue in dispute is whether a sum of HK$467,600 (i.e. equivalent to the government loan repaid by the couple in July 2004) out of the second bank loan should be considered as "home loan" under section 26E.
The taxpayer's contention
The evidence given by the taxpayer before the Board (the taxpayer represented herself in the hearing) was:
- The repayment of the government loan in July 2004 was out of sheer expediency and that the couple had all along intended to take out the second bank loan to replace the government loan once circumstances permit.
- The government loan must be repaid in July 2004 in order for the couple to enjoy a waiver of a 5% charge while the couple could not obtain the second bank loan earlier because (1) an earlier repayment of the first bank loan would be subject to pre-payment charge and (2) they had to wait for the premium figure assessed by the government organisation.
The Board's decision
The Board allowed the taxpayer's appeal on the following grounds:
- Whether the part of the second bank loan was used to replace the government loan is a matter of facts for the Board to decide and the Board accepted the taxpayer's evidence as to the reason why the repayment and loans happened at the time they did.
- The loan in question (i.e. the part of the second bank loan in the amount of HK$467,600) was in substance taken out for the purpose of replacing the government loan of a similar amount. It was only because of the rather unusual circumstances that the second bank loan could not be taken out earlier, and the couple had to provide a bridging finance for the short period between July and September 2004.
- Although the taxpayer could not show that the loan in question was used directly to acquire the dwelling (as the completion statement indicates that the sum was used to pay the premium), the factual situation falls within the spirit and intent of the legislation for home loan interest deduction, which requires the loan in question to be applied, as a matter of fact and substance, for the acquisition of the dwelling.
Our comment
In this case, the Board looked into the substance of the transactions effected by the taxpayer and applied section 26E in a way which, in the Board's view, represents a proper construction of that section. Given the specific facts and circumstances of the taxpayer, the Board was convinced that the taxpayer's original intention was to borrow the second bank loan to replace the government loan and to finance the payment of the premium by funds obtained from other sources. It was only because the taxpayer could not obtain the second bank loan in time that it had to first repay the government loan by a bridging finance and then apply the funds obtained from the second bank loan to pay the premium. Given the Board's interpretation of the spirit and intent of section 26E, the Board was of the view that the second bank loan should be treated as being applied to acquire the taxpayer's dwelling.
The Board also disagreed with the view taken in Board of Review Case D123/01 that when a person substitutes an original mortgage of his home by a subsequent mortgage, the Commissioner may not be obliged under the definition of home loan to continue granting that person the benefit of the home loan interest deduction and the current practice of allowing the deduction of the interest paid on a re-mortgaged home loan that replaces the original one is a concession exercised by the Commissioner. The Board found such view to be too narrow and that granting of a home loan interest deduction in the above situation is entirely justified under the law.
In the present case, there is a time gap of 2 months between the repayment of the original loan and the taking out of the second mortgage loan and the taxpayer was able to convince the Board that she and her husband had the intention to take out the second mortgage loan to replace the original loan. An interesting issue arising from the present decision is how much importance is being attached to the duration of the time gap between the repayment of the government loan and the taking out of the second bank loan in the Board's decision. In the present case, the duration of 2 months is comparatively short but other evidence given by the taxpayer also provides considerable support to the taxpayer's alleged intent. The issue of time gap between the repayment of the original loan and the taking out of the second mortgage loan is not specifically addressed in Departmental Interpretation & Practice Notes No. 35 (Revised) - Concessionary Deductions: Section 26E and 26F Home Loan Interest. There probably will not be a hard and fast answer to the question and the facts and circumstances of each case have to be examined individually. As a general rule, the longer the time gap, the less likely that the intent of taking out the second loan is to replace the original loan can be substantiated. |
