Related Party LRBA – Act Now

If your SMSF has (or is considering) a Limited Recourse Borrowing Arrangement (LRBA) and the borrowing is not with a regulated financial institution (e.g. the fund has borrowed from a related party), you should be aware that the terms of such borrowings are under ATO scrutiny.

If a borrowing is not on commercial terms then the non-arm’s length income (NALI) provisions in the Income Tax Assessment Act 1997 may apply to any income generated from the related asset. Any non-arm’s length income is taxed at the highest marginal rate (47% for the 2017 financial year).

Having said that, the ATO have stated that they recognise the effects of the NALI provisions and the importance of preserving assets held by an SMSF. Therefore, they will not select an SMSF for an income tax review purely because it has an LRBA for the 2014-15 income years and prior, provided that the trustees do one of the following:

  • ensure that any LRBAs in their fund are on terms consistent with an arm’s length dealing by 31 January 2017 (including payments of principal and interest for the year ended 30 June 2016) OR
  • bring the existing arrangement to an end by 31 January 2017 OR
  • refinance with a regulated financial institution by 31 January 2017.

If you choose to go with the first option of ensuring that existing LRBAs are consistent with arm’s length dealings, the ATO issued Practical Compliance Guidelines (PCG 2016/5) to set out the ‘Safe Harbour’ terms on which SMSF trustees may structure their LRBAs. The guidelines differ depending on the type of asset being purchased – a summary table is outlined below:

  Safe harbour 1: asset acquired is real property Safe harbour 2: asset acquired is a collection of stock exchange listed shares/units
Interest rate Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors. As aside + 2%
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.

 

 
As aside + 2%.

Fixed period up to a maximum of 3 years.

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.
Variable interest rate loan (original) – 7 year maximum loan term
Variable interest rate loan (re-financing) – maximum loan term is 7 years less the duration(s) of any previous loan(s) relating to the collection of assets
Fixed – with fixed period for a maximum of 3 years. The total loan term cannot exceed 7 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.
As aside with a maximum 50% LVR
Security A registered mortgage over the property is required A registered charge/mortgageor similar security(that provides security for loans for such  assets)
Personal guarantee Not required Not required
Nature & frequency or repayments Each repayment is of both principal and interest

Repayments are monthly

 

Each repayment is of both principal and interest

Repayments are monthly

 

Loan agreement A written and executed loan agreement is required A written and executed loan agreement is required

It should be noted that, if trustees have an arrangement that doesn’t meet the Safe Harbour guidelines, it doesn’t mean that the arrangement is not on arms’ length terms. However, trustees will need to be able to otherwise demonstrate, and provide evidence, that the arrangement was entered into and maintained on terms consistent with an arms’ length dealing.

The ATO has said that it will provide further information and ‘illustrative examples’ to assist SMSF trustees and their professional advisers. Whilst the ATO deadline to bring your arrangements into line is 31 January 2017, you should act as soon as possible in order to avoid any last minute complications.

Sources:

https://www.ato.gov.au/super/self-managed-super-funds/in-detail/news/ato-extends-deadline-for-review-of-non-arm-s-length-lrbas/?utm_source=Newsletter&utm_medium=email&utm_content=SMSF_newsletter&utm_campaign=SMSR_newsletter_20160726

https://www.ato.gov.au/law/view.htm?DocID=COG/PCG20165/NAT/ATO/00001

Want to stay up-to-date?

Stay on trend and in the know when you sign up for our latest content

Subscribe