On 15 December 2014 the ATO finally published its formal
view in ATO IDs
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;
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.
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