Background
In November 2015, the Australian Taxation Office (ATO) released 2 Interpretative Decisions, ATO ID 2015/27 (listed shares) and ATO ID 2015/28 (real property). These Interpretative Decisions deal with non-arm’s length income when there is related party non-commercial limited recourse borrowing arrangement (LBRA) to acquire the asset.
The ATO's view is that those income of a self managed super fund derived under a non-commercial limited recourse borrowing arrangement will be subject to the non-arms length income pursuant to section 295-550 of the Income Tax Assessment Act 1997 (ITAA97), i.e. the top marginal rate of tax (rate is currently 45%) regardless of whether the SMSF is in accumulation (normal accumulation rate of tax is 15%) or pension (normal pension rate of tax is 0%).
This is to prevent the situation where a SMSF enters into related party arrangements that are more favourable than normal commercial arrangement to gain a tax benefit. For example, shifting asset and thus income to a SMSF with related party loan at below market rate of interest or non-commercial repayment terms.
The ATO did not provide guidance on what would constitute a commercial arrangement. However, the Interpretative Decisions provided indicia of what may constitute a non-commercial arrangement, which included:
The ATO's conclusion is that no lender would provide lending on those terms is obvious. As a result, the arrangement would be caught by the non-arms length income rate of tax.
Safe harbour
To assist trustee in structuring related party loan to meet ATO's requirement to not be subject to the non-arms length income, the ATO published a Practical Compliance Guidelines PCG 2016/5. The Guidelines sets out the terms on which SMSF trustees may structure their LRBAs with related party loans that are acceptable to the ATO. The structuring of the related party loan in accordance with the guidelines will mean that the ATO will accept that the non-arms length income provisions do not apply.
Safe harbour for real property
The safe harbour applies for both residential and commercial premises.
| Interest rate | Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors. Applicable rates:
Interest rates for subsequent years: Rates and thresholds |
| Fixed / variable | Interest rate may be variable or fixed Variable - uses the applicable rate (as set out above) for each year of the LBRA Fixed - trustees may choose to fix the rate at the commencement of the arrangement for a specified period, up to a maximum of 5 years. The fixed rate is the rate published for May (the rate for the May before the relevant financial year). The 2015-16 rate of 5.75% may be used for LRBAs in existence on publication of these guidelines, if the total period for which the interest rate is fixed does not exceed 5 years (see 'Term of the loan' below). |
| Term of the loan | Variable interest rate loan (original) - 15 year maximum loan term (for both residential and commercial) Variable interest rate loan (re-financing) - maximum loan term is 15 years less the duration(s) of any previous loan(s) relating to the asset (for both residential and commercial) Fixed interest rate loan - a new LRBA commencing after publication of these guidelines may involve a loan with a fixed interest rate set at the beginning of the arrangement. The rate may be fixed for a maximum period of 5 years and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 15 years. For an LRBA in existence on publication of these guidelines, the trustees may adopt the rate of 5.75% as their fixed rate, provided that the total fixed-rate period does not exceed 5 years. The interest rate must convert to a variable interest rate loan at the end of the nominated period. The total loan cannot exceed 15 years. |
| Loan to Market Value Ratio (LVR) | Maximum 70% LVR for both commercial and residential property If more than one loan is taken out to acquire (or refinance) the asset, the total amount of all those loans must not exceed 70% LVR. The market value of the asset is to be established when the loan (original or re-financing) is entered into. For an LRBA in existence on publication of these guidelines, the trustees may use the market value of the asset at 1 July 2015. |
| Security | A registered mortgage over the property is required |
| Personal guarantee | Not required |
| Nature & frequency of repayments | Each repayment is of both principal and interest Repayments are monthly |
| Loan agreement | A written and executed loan agreement is required |
For the 'safe harbour' terms that applies to listed securities, see LRBA safe harbour for listed securities.
Existing arrangement
The Guidelines applies regardless of whether the LRBA commenced before or after the date of publication of the Guidelines. However, the ATO will not take any action on existing arrangements if those arrangements are on terms that are consistent with the 'safe harbour' terms by 30 June 2016 or bring the LBRA to an end by that date.
Specifically, the ATO stated that it would not be selecting SMSFs for review for the 2014-15 year or earlier years purely because the fund has entered into an LRBA.
If you have an existing LRBA with a related party loan, you should seek advice or contact us to review the arrangement to ensure that the arrangement will be maintained on terms consistent with an arms' length dealing going forward.
The ATO stated that trustees who satisfy the Guidelines in good faith to revised the terms of their existing LRBA before 30 June 2016 can be assured that the terms of their LRBA will not be subject to compliance action by the ATO for the 2014-15 year and prior.
Arrangements that are not on safe harbour terms
Where a loan arrangement departs from the 'safe harbour' terms, the trustee will need to be able to demonstrate that the arrangement entered into and maintained on terms consistent with an arms' length dealing. The trustee will need to demonstrate that it is on arms' length by maintaining evidence that shows that the arrangement replicates the terms of a commercial loan that is available in the same circumstances.
For example, where the LVR or interest rate is more favourable that the 'safe harbour' terms, practically, this may mean that the trustee will need to go through the process of applying for the loan and have a loan offer from a bank as evidence of those terms upon which will be replicated.
Do you need help with your situation or if you wish to discuss the above, please contact us. Our contact details.
