The ATO has finally published guidance on what relief a related party lender can provide an SMSF in relation to the repayment of related party loans. Click here for the ATO's guidance.
Related party loan issues
Some limited recourse borrowing arrangements (LRBAs) by SMSFs involve related party loans to the SMSF.
These loans must be on arm's length terms. This is will be the case where the loan either:
- complies with the safe harbour loan terms set out by the ATO in PCG 2016/5
- is on the same terms as would be offered by an unrelated lender in the same circumstances (established by independent evidence).
The related party loan must then be maintained strictly in accordance with the loan terms.
If either of these requirements is not satisfied, there can be a number of issues for the SMSF, including that the non-arm's length income rules may apply. Where this is the case, all the income of the investment will be taxed at the top marginal tax rate, rather than the concessional rates for SMSFs.
As a result, a related party lender providing an SMSF any relief from loan repayments would ordinarily trigger significant adverse consequences for the SMSF.
LRBA loan – ATO position
The ATO have confirmed that a related party lender can provide relief to an SMSF from loan repayments; however there are some conditions and potential traps. This relief is more limited than other announcements made by the ATO (such as for rent relief).
Relief the ATO will accept
For related party loans, the ATO will only accept that the loan relief will not trigger the non-arm's length income rules where the relief provided is consistent with what a commercial bank is currently offering.
Relief provided will be consistent with that offered by commercial banks where:
- it can be established through independent evidence that a commercial bank would have provided the same relief
- the relief provided is consistent with the relief packages published on the Australian Banking Association's website – click here.
Currently, the Australian Banking Association provides that lenders will provide a deferral of loan repayments for up to six months on the following basis:
- interest will continue to be accrue during the deferral period
- accrued interest is to be capitalised and form part of the amount to be repaid
- the Borrower must be able to show they have been financially impacted by COVID-19
- the Borrower must not terminate a lease or evict a tenant for rent arrears during the loan deferral period.
The ATO specifically requires that, to qualify for the relief, documentation is required for both the:
- change to the loan terms
- reasons for the change.
What if my related party loan is on Division 7A terms?
Some loans from related parties to SMSFs must also comply with Division 7A terms. At this stage there is no equivalent relief from Division 7A, and the ATO have indicated that they are still reviewing their position on this.
As a result, if the related party loan must also comply with Division 7A, then the loan must continue to satisfy these requirements. This includes making the minimum yearly repayment.
Practically, where a related party loan to an SMSF for an LRBA must also comply with Division 7A, this means:
- the related party lender can provide relief by deferring the monthly principal and interest repayments; but
- before the end of the financial year, the total repayments made on the loan must still be at least the minimum yearly repayment required by Division 7A.
Other limitations on ATO relief
This announcement by the ATO is more limited than other relief announced by the ATO (which gave the parties much more discretion to determine what relief is suitable in the circumstances).
In particular, this ATO announcement does not allow a related party lender to provide the following relief (unless there is independent evidence from a commercial lender) for an LRBA loan:[C21]
- extension to the loan term
- change to the interest rate.
Loans to unit trusts – ATO position
Unfortunately, the ATO's announcement does not extend to related party loans to a unit trust where the SMSF is a unitholder. This is really disappointing, given the same non-arm's length income issues arise in this situation.
Even though the ATO's announcement is specifically limited to LRBAs, it is our view that a related party lender can provide the same relief to a unit trust borrower. This is because the relief permitted by the ATO is linked to what a commercial lender would provide in the circumstances.
What should SMSFs and related party lenders do?
In summary, to qualify for the relief, SMSFs and related party lenders must:
- be able to demonstrate the financial impact on the SMSF caused by COVID-19
- show that the relief provided is consistent with an arm's length lender (either by following the announced relief packages on the Australian Banking Association website or being able to provide their own independent evidence)
- document change to the loan terms and the reasons for the change
- continue to strictly comply with the terms of the loan.
Although the ATO announcement is useful, practically it will only provide SMSF borrowers with short term cash flow relief during the current crisis. As the terms of the loan will generally not be able to be extended, after the deferral period is over the SMSF borrower will have to make bigger monthly repayments for the loan to be repaid in full by the end of the loan term.
Cooper Grace Ward is a leading Australian law firm based in Brisbane.
This publication is for information only and is not legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as legal advice. If there are any issues you would like us to advise you on arising from this publication, please contact Cooper Grace Ward Lawyers.