SMSFs and arm's length loan terms for related party Limited Recourse Borrowing Arrangements
The Australian Taxation Office (ATO) has released Practical Compliance Guideline 2016/5 (PCG 2016/5) to assist trustees of self-managed superannuation funds (SMSFs) in structuring limited recourse borrowing arrangements (LRBAs), where the borrowing is provided by a related party. The release of PCG 2016/5 comes as no surprise, which follows on the back of the ATO publications ATO ID 2015/27 and ATO ID 2015/28.
Where an LRBA with a related party lender is established and the loan is not on commercial terms, the ATO may classify the income from the arrangement as non-arm’s length income, which is subject to tax at the highest marginal rate. The Guideline sets out the terms on which SMSF trustees may structure their LRBAs so that the ATO will accept the LRBA as being an arm’s length dealing.
The table shows the borrowing terms the ATO considers are consistent with an arm’s length dealing:
|Loan Feature||Real property (residential or commercial)||Shares/units listed on a stock exchange|
|Interest rate benchmark||Reserve Bank Indicator Lending Rates for banks providing standard variable housing loans for investors, plus 2% for loans relating to shares/units|
|Interest rate||2015/16: 5.75% 2016/17 and later years: the rate for the May immediately prior to the financial year end||2015/16: 7.75% 2016/17 an later years: the rate for the May immediately prior to the financial year end + 2%|
|Repayment type||Variable or fixed. Maximum five years for fixed rate terms||Variable or fixed. Maximum three years for fixed rate terms|
|Loan term||Maximum of 15 years||Maximum of 7 years|
|Loan to value ratio||70%||50%|
|Security||Registered mortgage over property||Registered charge/mortgage or similar security|
|Personal guarantee||Not required||Not required|
|Repayment frequency||Monthly. Must be principal and interest||Monthly. Must be principal and interest|
|Loan agreement||Written and executed||Written and executed|
The Guideline states that the ATO will not select an SMSF for a tax review for the 2014/15 year solely because of an LRBA arrangement. However, this is conditional on SMSF trustees either ensuring the LRBA terms are consistent with the Guideline or bringing the LRBA to an end by 30 June 2016. Additionally, payments of principal and interest for the 2015/16 financial year must be made under LRBA terms consistent with an arm’s length dealing.
Note that trustees may enter into an LRBA that is inconsistent with the Guidelines, but they must demonstrate that the arrangement was entered into and maintained on terms consistent with an arm’s length dealing. This may be by replicating the terms of a commercial loan that is available in the same circumstances.
Before 1 July 2016 advisors should take the following actions:
- Review their clients’ LRBAs where there are related party loans, and check the terms against the safe harbour rules.
- Where an LRBA relates to real property or to listed shares or units, ensure that action is taken before 30 June 2016 where necessary to:
- amend the terms of such loans, so as to bring these within the safe harbour rules, and ensure that payments of principal and interest on the amended basis are made for the year (or form a view as to whether any deviations are of such significance as to require attention); or
- refinance through a non-related lender (i.e. on actual arm’s length terms); or
- pay out the loan (and ensure that payments of principal and interest are made for the year on terms consistent with an arm’s length dealing).
- Where an LRBA relates to any other asset, consider whether the trustee of the SMSF is in a position to demonstrate that the terms are consistent with commercially available terms.