One of the major issues with LRBAs has been around the terms of loans from related parties.
While the ATO had been making comments, there remained some doubt around what would be considered arm's length terms for related party loans with LRBAs. The ATO has now released PCG 2016/5 to provide guidance on this. It contains safe harbour terms that the ATO will accept are arm's length, which means the income from the LRBA will not be considered non-arm's length income to the SMSF purely because of the terms of the borrowing.
What are the safe harbour rules?
When must the LRBA comply by?
The safe harbour rules apply both to existing LRBAs and those established from now on.
The ATO confirms they will not select an SMSF for an income tax review for the 2014-15 or earlier years purely because the SMSF has entered into an LRBA provided that, by 30 June 2016:
- all loans are on terms consistent with an arm's length dealing, or the LRBA is wound up; and
- the SMSF trustee has made principal and interest payments for the 2015/16 year that are consistent with an arm's length dealing.
Are there other options?
The ATO accepts that alternative loan terms can be appropriate, but the onus will be on the SMSF to establish they are consistent with an arm's length dealing.
The options for SMSFs with LRBAs that have loans from related parties are to:
- ensure the terms of the related party loan comply with the safe harbour rules by 30 June 2016 (including making principal and interest payments for the 2015/16 year consistent with an arm's length dealing);
- wind up the LRBA by 30 June 2016 (for example by selling the asset or paying out the debt and transferring it to the SMSF), having made principal and interest payments for the 2015/16 year consistent with an arm's length dealing; or
- ensure they have extrinsic evidence that the terms of the existing arrangement are consistent with an arm's length dealing (e.g. because they are substantially the same as an offer of finance from a bank).
Is it just the loan terms to worry about?
The terms of the loan are an important part of an LRBA, but there are many other rules that are just as important, and a breach of any of them can result in compliance issues for the SMSF or for the income from the LRBA to be non-arm's length income to the SMSF, which will be taxed at the top marginal tax rate.
- SMSF borrowing (LRBAs), related party loans and 1 July 2016 – there's more involved than you think. Are you ready?
- SMSFs and LRBAs: ATO finally clarifies its position on zero interest loans from related parties and non-arm's length income
- Limited recourse borrowing arrangements: SMSFs watch out! ATO changes its view on non‑arm's length income
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.