SMSF borrowing arm's-length terms deadline extended

Thursday 4 August 2016

The ATO has extended until 31 January 2017 the deadline for SMSF trustees to ensure that any related-party limited recourse borrowing arrangements (LRBAs) are on terms consistent with an arm’s-length dealing.

The ATO had previously announced a grace period whereby it would not select an SMSF for review for the 2014–2015 year or earlier years provided that arm’s-length terms for LRBAs were implemented by 30 June 2016 (or non-compliant LRBAs were brought to an end before that date).

The extension of the deadline to 31 January 2017 follows the ATO’s release of Practical Compliance Guideline PCG 2016/5, which sets out “safe harbour” terms for LRBAs. If an LRBA is structured in accordance with PCG 2016/5, the ATO will accept that the LRBA is consistent with an arm’s-length dealing and the non-arm’s length income (NALI) rules (47% tax) will not apply to the income generated from the LRBA asset.

Arm’s length terms by 31 January 2017

The Commissioner has received several requests from SMSF trustees for further time to ensure that their LRBAs are consistent with arm’s-length dealings.

These requests also highlighted that taxpayers may benefit from further ATO guidance about some aspects of the NALI provisions under s 295-550 of the ITAA 1997. For example, they suggested clarifying the circumstances in which an SMSF would be taken to receive a greater amount of ordinary or statutory income under a particular non-arm’s length arrangement than it would have received under an arm’s-length arrangement. The ATO intends to provide further information and illustrative examples by 30 September 2016.

If SMSF trustees ensure that any related-party LRBAs have terms consistent with an arm’s-length dealing by 31 January 2017 (or are brought to an end by that date), the Commissioner will not select an SMSF for an income tax review purely because it has an LRBA for the 2014–2015 and earlier income years.

Importantly, the ATO requires payments of principal and interest for the year ended 30 June 2016 to be made under LRBA terms consistent with an arm’s-length dealing by 31 January 2017 (including where the arrangement is brought to an end before 31 January 2017).

ATO safe harbour terms

Broadly, the ATO’s safe harbour terms in PCG 2016/5 require an interest rate of 5.75% (for 2015–2016) for a related-party LRBA used to acquire real property (residential or commercial).

Other requirements include that:

• the term of the loan cannot exceed 15 years;
• a maximum 70% loan-to-value ratio (LVR) applies;
• repayments must be made monthly; and
• a registered mortgage is required but personal guarantees are not.

If an LRBA does not meet all of the safe harbour terms by 31 January 2017, it does not mean that the borrowing is deemed not to be on arm’s-length terms. Rather, trustees who do not meet the safe harbour terms will need to otherwise demonstrate that their arrangement was entered into and maintained consistent with arm’s-length terms.