Muses of a retired tax accountant MUSING ON SOME THORNY QUESTIONS ON THE TOTAL ASSET METHOD (10 of 13)

8.5 A teeny-weeny bit more on direct identification and tracking

“Huh? Aren’t you done on this topic?”

“Afraid not.”

“What is it now?”

“My thoughts kept returning to this statement about not feasible to identify and track. The questions in my head are: why is it not feasible? Because it is too tedious, too complex to follow the flow of funds, or because money is homogenous and thus cannot track? Etc. etc.”

To put things in perspective, I assume this common understanding of direct identification and tracking.

In simplicity, this involves three steps. One, pinpoint what interest-bearing borrowing funded the purchase of an asset. Two, follow the money flow from the funding source to the asset vendor. Three, determine the interest charged on this borrowing.

In almost all situations, the first step (i.e. the “identify” step) should not cause a problem. (Come to think of it, I wonder if there could be exceptions. But at the moment can think of none.)

The second step (i.e., fund use) shouldn’t be an issue. For this segment of my muses, I ignore whether it’s a direct or indirect use.

From prior experience, the third step gives the most headache. Sometimes unbearably so.

“If you can identify it, why must you laboriously track it yourself?” Voice suddenly cut off my flow of thoughts.

“What do you mean?”

“Pay your bank an administrative fee and ask it to confirm what interest expense it charged on the particular borrowing taken out to fund the asset purchase.” Voice said with a smug.

Not sure about more complex banking facilities. But what about overdraft facilities and those like an overdraft arrangement? The idea from Voice grew on me.

I got this from ChatGPT:

?“Overdraft interest is typically calculated as a percentage of the outstanding balance. The specific formula used may vary depending on the financial institution, but the common method is to calculate interest daily based on the daily balance of the overdraft, and then add up the daily interest charges for the billing period. The interest rate and billing period will also vary depending on the financial institution and the terms of the account agreement. It is always a good idea to check with your specific bank or credit union to understand the details of how they calculate overdraft interest.”

“Are we interested in how a bank charges the interest on an overdraft account?”

“No. How the bank charges is a contractual agreement between it and the borrower. This shouldn’t be relevant here. We should be interested in the amount of interest it charged on those drawdowns to fund the asset purchase."

"Why?" Voice asked testily.

I play around with this theory in my head. The law talks about interest expense incurred. Banks employ technology, algorithms and whatnot to automate the interest calculation on overdrafts. Whether or not banks use Clayton’s Rule is irrelevant. They must be able to tell the interest it charged on the drawdown to fund the asset purchase, from the inception of the drawdown to the repayment of the borrowing created by this drawdown. This should meet both the identification and tracking conditions. If so, this chunk of overdraft interest expense becomes a specific interest expense rather than a common interest expense. Identified and tracked!

“Surely this classification as a specific interest expense is a matter for the discretion of the IRAS! Is it not?” Voice was now outright provocative.

“True.”

“I see the dilemma here. With the bank’s help, the taxpayer can track, even with precision. But the eTaxGuide says the TAM will ignore the tracking, as in ‘no need to identify’. The question is whether an administrative discretion is unreasonable if it disregards the facts and evidence given by a third party.”

“What if the bank’s written response was the overdraft interest charged for the current period did not include any interest charges for the prior drawdowns on the dates indicated in the confirmation request?”

“If this is the confirmation from the bank, then it suggests one thing – the prior drawdowns are not included in the overdraft balance outstanding in the current period.”

“Meaning?”

“The debts due to the bank on the prior drawdowns had been repaid before the current period. That’s why these prior drawdowns are not included in the outstanding balance for the current period.”

“Meaning?”

“Meaning the overdraft interest expense for the current period should not be attributed, even in part, to the assets purchased with the prior drawdowns.”

“I see. Because the indebtedness created by the prior drawdowns had been extinguished, the entire amount of the overdraft interest in the current period should not be subject to the TAM. Is that what you are saying??

“Exactly! Here, the taxpayer identified, and the bank did an ‘inverse tracking’. Since the current outstanding in the overdraft does not include any amount previously owed to the bank, the interest expense incurred for the current period is neither a specific interest expense nor a common interest expense!”

“What happens then?”

“You exclude this portion of the interest expense from the common interest expense used in the TAM.”

“Just like that?

“Yes.”

“You think the IRAS buys your logic?”

“No idea.”

After a pause, I said, “It depends on how hard IRAS stands by the underlying assumption and the TAM as the default method. And whether the court thinks disregarding actual facts and denying a taxpayer’s entitlement to a deduction under Section 14(1)(a) is not unreasonable in the Wednesbury sense.”

Voice nodded in silence.

“One more thought. Here, the taxpayer can show there is no nexus between the current borrowings and the prior drawdowns to fund the purchase of, say, a non-income-producing asset. Yet doesn’t insist on applying the TAM increase the taxpayer’s tax burden?”

“Hmm. Good luck to you!”.

Paragraph 5.5 of the eTaxGuide offers another example. It says:

“When the specific interest-bearing loan is fully repaid, the cost of asset financed by the loan should be included in the “Cost of Total Assets” (i.e. the denominator of the TAM formula) in subsequent YAs. This inclusion is in line with the application of the TAM where only the costs of assets financed by specific interest-bearing loans can be excluded from the TAM computation.”

“If this asset remains non-income producing for many years after the specific loan has been repaid, the common interest expense having nothing to do with the funding for this asset is TAM’d. Isn’t this another case of administrative discretion increasing the taxpayer’s tax burden?”

Voice was stoically quiet.

(Continue in the next instalment.)?