The ATO has created a safe harbour from the Non-Arm’s Length Income Rules for SMSFs with Limited Recourse Borrowing Arrangements (LRBAs), in Practical Compliance Guideline 2016/5.
Update: The ATO has given SMSFs an, extended, deadline of 31 January 2017 to review potentially non-arm’s length LRBAs.
For some time the ATO has been issuing warnings, and interpretative decisions (ATO ID 2015/27 and ATO ID 2015/28), about the application of the Non-Arm’s Length Income Rules (NALI) to some LRBAs. In short, a non-arm’s length LRBA could result in income from that arrangement being taxed at top marginal rates (plus the temporary budget repair levy) in the SMSF instead of the normal super fund tax rates.
The ATO has now issued Practical Compliance Guideline (PCG) 2016/5, which sets out a safe harbour from the NALI rules for SMSFs. PCG 2016/5 applies to LRBAs entered into both before and after the issue of the Guideline.
This Guideline sets out the ‘Safe Harbour’ terms on which SMSF trustees may structure their LRBAs consistent with an arm’s length dealing. That is, for income tax compliance purposes, the Commissioner accepts that an LRBA structured in accordance with this Guideline is consistent with an arm’s length dealing and that the NALI provisions do not apply purely because of the terms of the borrowing arrangement.
The ATO says that just because a LRBA doesn’t meet the requirements of the PCG doesn’t mean that NALI will apply.
“If SMSF trustees have entered into an arrangement which does not meet all of the ‘Safe Harbour’ terms set out in this Guideline, whilst the trustees are unable to be assured that the Commissioner will accept the arrangement to be consistent with an arms’ length dealing, it does not mean that the arrangement is deemed not to be on arms’ length terms. It merely means that there is no certainty provided under this Guideline.”
“The trustees will need to be able to otherwise demonstrate that the arrangement was entered into and maintained on terms consistent with an arms’ length dealing. One example of how a trustee may demonstrate this is by maintaining evidence that shows their particular arrangement is established and maintained on terms that replicate the terms of a commercial loan that is available in the same circumstances.”
PCG 2016/5 sets out a number of requirements for the Safe Harbour to apply to LRBAs for both real property and listed share/unit. These requirements deal with:
- Interest rates
- Term of the loan
- Personal guarantees
- Nature and frequency of repayments
- Loan agreements
The ATO looks to interest rates published by the RBA for its benchmarks, with an adjustment for shares. Both variable and fixed rates are allowed, though with a maximum term for fixed. The Safe Harbour allows a maximum 70% LVR for commercial or residential property and 50% for shares or units. Personal guarantees are not required, though property requires a registered mortgage and shares/units a “registered charge/mortgage or similar security”. Monthly repayments of both interest and principal are required for property and shares/units, along with a “written and executed loan agreement”.
Note that the PCG deals with real property, “shares in a stock exchange listed company” and “units in a stock exchange listed unit trust”.
The ATO also sets out examples of an LRBA not on arm’s length terms and the steps that could be taken to bring it within the Safe Harbour. These include altering the terms of the loan – including repaying of principal to reduce the LVR and changes to the interest rate and repayments – refinancing through a commercial lender or paying out the LRBA.
The ATO also used PCG 2016/5 to encourage SMSFs to review LRBAs before 30 June 2016.
“The ATO recognises the effects of the NALI provisions, and the importance of preserving assets held by an SMSF. Given this, we will not select an SMSF for an income tax review for the 2014-15 year or earlier years purely because the SMSF has entered into an LRBA. However, this is conditional on the SMSF trustee ensuring that any LRBAs that their fund has is on terms consistent with an arm’s length dealing by 30 June 2016 or, alternatively, is brought to an end by 30 June 2016.”
“In addition, payments of principal and interest for the year ended 30 June 2016 must be made under LRBA terms consistent with an arm’s length dealing. SMSF trustees who are concerned about their ability to make the required payments on commercial terms before 30 June 2016 can contact the ATO to discuss their particular circumstances.”
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