SMSF Trustees who have established a limited Recourse Borrowing Arrangement(LRBA) with a loan from a related party should ensure the terms of the loan are made on an arms-length basis by 30 June 2016.

Where the terms of the loan and the ongoing operation of the loan are not consistent with an arms-length arrangement, the ATO is likely to determine that the asset gives rise to non arms-length income (NALI). NALI is taxed at the highest marginal rate – 47% for the 2015/16 financial year.

To determine if the arrangement is arms-length, the following factors must be considered:

  • Nature of the acquirable asset
  • Amount borrowed
  • Term of the loan
  • Loan-to-value ratio
  • Interest rate charge, or the other means by which the lender is compensated for the opportunity, cost in lending the principal
  • Regulatory and frequency of principal repayments required
  • Security taken for the borrowers’ performance under the loan, given the limited recourse nature of the loan
  • Extent to which the loan is operated in accordance with its terms
  • The ATO released two recent interpretive decisions (ATO ID 2015/27 and ATO ID 2015/28) where funds had related party lending and failed to satisfy the arms-length rule based on the facts of each case.

SMSF Trustees should review any LRBA to ensure that the terms are established and maintained on an arms-length basis. The ATO encourages Trustees to take steps to ensure the terms are consistent with an arms-length dealing by 30 June 2016 or to cease the LRBA at this point. Any new LRBAs must be established and maintained on an arms-length basis.

Implications for Clients

  1. Trustees should be aware that related borrowing on less than commercial interest rates and/or terms may result in non arms-length income subject to penalty tax. A private binding ruling should be sought.
  2. LRBA related party borrowing at commercial rates and terms is unlikely to generate non arms-length income.
  3. Review existing related party borrowing arrangements to determine if they are impacted and identify any action required before 30 June 2016.

 

 

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David Watkins, has been providing advice to clients since 1987. He is a Certified Financial Planner, a member of the Financial Planning Association (FPA), and Superannuation Professionals Association of Australia (SPAA).Google Plus

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