On 15 December 2014 the ATO finally published its formal view in ATO IDs 2014/39 and 2014/40 on interest-free (0%) or low rate loans to self-managed superannuation funds (SMSFs) from related parties for limited recourse borrowing arrangements (LRBAs) and whether that gives rise to non-arm's length income in the SMSF.
The ATO also discusses the impact of other non-commercial terms, and the risk of those loans giving rise to non-arm's length income as well.
Zero interest rates
These ATO IDs confirm our interpretation of the ATO's position in our April alert – all the income received by an SMSF from an LRBA will be non-arm's length income (formerly 'special income') and taxed at the top marginal rate where the SMSF has borrowed from a related party on an interest-free basis. The top marginal rate will apply even if the SMSF is in pension phase.
The ATO's view is based on the fact that the SMSF would not have entered into the arrangement (and therefore would have received no income) had the loan been on arm's length terms and interest was payable at market rates.
The ATO IDs go further and indicate the non-arm's length income rules would still apply even if the SMSF could have entered into the same LRBA but with an arm's length loan, or even without the borrowing.
Other loan terms
Even if commercial interest is payable, the ATO have indicated that the income from an LRBA will be non-arm's length income if any of the other terms of the loan are not consistent with an arm's length dealing.
In particular, the ATO has emphasised the following loan terms are under review:
- the loan-to-value ratio;
- the term of the loan;
- repayment frequency;
- whether principal repayments were required;
- the security provided; and
- whether there are guarantees.
Action required and take away lessons
If you have clients with interest-free, low rate loans or other loan terms that are not commercial, you should consider varying the loan agreement to reduce the risk of a non-arm's length income assessment for future years.
Where clients are looking to enter into a new related party loan, exercise extreme caution to ensure all the terms of the loan can be justified as being commercial. The best evidence of commercial terms is a contemporaneous quote from a commercial lender outlining the terms they would be prepared to lend on.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.