SMSF related party borrowings under ATO scrutiny

An LRBA allows the trustee of an SMSF to borrow funds to purchase a ‘single acquirable asset’, usually real property or a parcel of direct shares.  Purchasing assets through an SMSF is often used as part of a tax effective wealth accumulation strategy for the following reasons:

  • SMSFs are generally subject to an income tax rate of just 15%
  • Tax on SMSF capital gains may be levied at just 10%
  • Where the SMSF pays pensions to its members, its tax rate may be reduced to nil.

In some circumstances, an LRBA may enable an SMSF to purchase assets which it would otherwise be unable to acquire, particularly where an SMSF has insufficient funds available.

For example, an SMSF with $250,000 of available cash may be able to purchase an asset worth $500,000 by borrowing the additional 50% from a financial institution or related party of the SMSF.  This may dramatically increase the SMSF’s ability to leverage its existing asset base to acquire substantial investments.

Certain limitations apply (find out more here).

‘Non-arm’s length’ arrangements

There are no restrictions on who can lend money to an SMSF under an LRBA.  In most circumstances the SMSF will borrow money from a bank or financial institution.  However, related parties, including SMSF members, may also lend money to an SMSF under an LRBA.

For example, a business owner may provide a loan to his or her SMSF in order to purchase the commercial premises from which the business operates.  It is not uncommon in such situations for the loan to be on terms favourable to the SMSF – for example, the business owner may charge very low (or zero) interest and the term of the loan may be over 50 years. A loan of this nature would be considered ‘non-arm’s length’ as no commercial lender would offer a loan on these terms.

In December 2015, the ATO announced that they would be reviewing all ‘non-arm’s length’ LRBAs.  Any income received by an SMSF using a loan that is not considered to be at arm’s length will be taxed at the top marginal tax rate (currently 45%) rather than the concessional rate (currently 15%) which usually applies to complying superannuation funds.

The ATO has provided some guidance on what it considers to be commercial terms in the Practical Compliance Guideline PCG 2016/15, and further examples recently released in Taxation Determination TD 2016/16.

The guidelines differ for real property and secured assets.  They are reasonably complex and open to interpretation.  However, in broad terms an LRBA will be considered (in the ATO’s view) to be at arm’s length if:

  • The interest rate is in line with the Reserve Bank of Australia’s Indicator Lending Rates (differing rates are used for real property and secured assets)
  • The term of the loan is 15 years or less
  • The loan-to-market ratio is in line with benchmarks set by the ATO.

The ATO has given SMSFs until 31 January 2017 to ensure any LRBAs are on commercial arm’s length terms.  As above, those on non-arm’s length terms that do not comply will be taxed at the top marginal tax rate.

Next Steps

We recommend that any SMSF with a related party LRBA seek professional advice to determine whether the loan would be considered arm’s length and on commercial terms. Where the loan is considered to be non-arm’s length, you will have until 31 January 2017 to ensure the LRBA is on terms consistent with an arm’s length dealing (such as by amending the terms of the loan and pay any outstanding interest), or bringing the LRBA to an end.

William Buck’s superannuation experts are up to date with the latest changes in legislation. If you require advice on reviewing your LBRA or any other SMSF issue, please contact your local William Buck advisor.

SMSF related party borrowings under ATO scrutiny

Charis Liew

Charis is a Director in our Superannuation team and has developed a niche in self-managed super funds and small-to-medium enterprises. Having joined the firm as a graduate, she quickly developed a specialisation in superannuation and tax, allowing her to offer expertise across two disciplines. Charis' unique background allows her to add value through strategic management of taxation and superannuation laws.

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