Protected equity loans

These are typically fixed term investment loans (interest only with principal repaid in one lump sum at maturity) used to acquire a portfolio of shares.

These are typically fixed term investment loans (interest only with principal repaid in one lump sum at maturity) used to acquire a portfolio of shares. Similar to instalment warrants, they are limited recourse loans. The investor is protected from a fall in the price of the shares as the loan facility includes a capital protection feature that gives the investor the right to transfer the shares back to the lender as repayment of the loan. The lender in turn covers this risk by buying a put option, the cost of which is passed on to the borrower.

The Australian Tax Office places restrictions on the deductibility of interest expense associated with protected equity loans. The portion of interest expense related to the cost of capital protection is not deductible. It’s instead treated as a capital expense rather than an income expense. While not deductible, this portion is included in the cost base of the investment for Capital Gains Tax purposes. A benchmark is used to determine the portion of a capital protected borrowing’s interest expense that is tax deductible, with the remainder treated as a capital expense. The current benchmark is the Reserve Bank’s standard housing rate plus 100 basis points. Transitional rules apply to capital protected borrowings entered into on or before 13 May 2008. The Australian Tax Office provides instructions on how to calculate deductions for a capital protected borrowing.

What are the benefits

In addition to the general benefits of gearing:

  • the ability to borrow the entire amount i.e. 100% loan to valuation ratio (LVR)

  • limited recourse with potential loss restricted to borrowing costs prior to exercising the put option.

What are the risks?

The primary risk associated with this type of loan is the extra cost due to the embedded put option. This may exceed the future returns generated by dividends and capital gains. Careful assessment of the investment performance should be undertaken before taking on a protected equity loan for an investor to break even or receive a profit.

Download "Your guide to gearing".

There are a number of ways you can gear an investment and a number of investments you can hold with gearing.

Contact BT Technical Services for more information

While gearing has advantages, using savings to gear on a regular basis can offer additional benefits. Regular gearing combines savings with borrowed funds.
There are a number of ways you can gear an investment and a number of investments you can hold with gearing.
Annuities can be purchased within superannuation or personally. There are two main types, fixed term and lifetime options which are subject to specific rules.

FOR ADVISERS USE ONLY

This information has been prepared by BT, a part of Westpac Banking Corporation ABN 33 007 457 141 AFSL 233714 (Westpac), for financial advisers only and must not be made available to any client or any other person, or attributed to Westpac or any other company in the Westpac group.

The information is an overview only and it should not be considered a comprehensive statement on any matter nor relied upon as such. Any graph, case study or example is for illustrative purposes only and is not an indication of future performance or result. Where past performance is used, please note that past performance is not a reliable indicator of future performance. Any taxation information is a general statement based on current laws and their interpretation. The article is current as of the date of the article unless stated otherwise. The article does not contain, and should not to be taken to contain, any financial product advice and it does not take into account any person’s financial situation, needs, objectives or taxation situation. Because of this, you should, before acting on the information, consider its appropriateness to your clients, having regard to their financial situation, needs and objectives, and your clients should seek independent professional taxation advice on any taxation matters. It is not the intention of Westpac or any member of the Westpac group that the information be used as the primary source of readers’ information but as an adjunct to their own resources and training and should therefore not be relied on for the purposes of making any financial recommendations or an investment decision. To the maximum extent permitted by law: (a) no guarantee, representation or warranty is given that any information or advice in this website is complete, accurate or up to date or fit for any purpose; and (b) no member of the Westpac group is in any way liable to you (including for negligence) in respect of any reliance upon such information.

This page may also contain links to websites operated by third parties (‘Third Parties’) who are not related to the Westpac Group (‘Third Party Web Sites’). These links are provided for convenience only and do not represent any endorsement or approval by the Westpac Group of those Third Parties or the information, products or services displayed or offered on the Third Party Web Sites.