SELF MANAGED SUPER FUNDS
The Commissioner of Taxation is continuing to focus the ATO’s attention on the regulation and compliance of self-managed super funds (“SMSFs”). This focus includes an ongoing and concerted push towards ensuring that SMSFs are compliant in respect of the terms of ‘Limited Recourse Borrowing Agreements’ (“LRBAs”) between SMSFs and related parties.
The ATO have released Practical Compliance Guideline (PCG 2016/5) setting out the “safe harbour terms” on which the ATO will classify an LRBA as being commercial with arms length terms. PCG 2016/5 has been released with the express purpose of providing SMSF Trustee’s with sufficient time to structure (or re-arrange) their affairs prior to 30 June 2016. It is important to note that the ATO’s compliance note is not an exhaustive position on what arrangements will be compliant and what will not.
What is an LRBA?
A Limited Recourse Borrowing Agreement (“LRBA”) is a form of borrowing often utilised by a SMSF to acquire income generating asset(s). A typical example of an LRBA includes:
- A SMSF Trustee borrows money from a lender to acquire a commercial property or parcel of shares;
- The lender can be a related entity to the members of the SMSF;
- The borrower is the SMSF Trustee;
- A bare trust is established and the Trustee of the bare trust is the legal owner of the property, until the loan is repaid; and
- Importantly, the lender only has recourse to the property the subject of the bare trust, and cannot pursue other SMSF assets to satisfy repayment of the loan.
Sounds Boring – Why Should You Care?
Put simply, because your SMSF could pay more tax.
If the ATO determines that an LRBA is not on a commercial and arms lengths basis, the income that is generated from the acquired asset can be classed as Non-Arms Length Income (“NALI”). Any income classified as ‘NALI income’ is taxed at the highest marginal tax rate.
What Constitutes Commercial and Arms Length?
PCG 2016/5 specifies the following minimum guidelines for ensuring LRBAs are commercial and at arms length. Some examples, as they relate to real estate include:
- The loan to valuation ratio is no greater than 70% of the asset’s market value at the time the LRBA is entered into;
- The loan term should not exceed 15 years;
- Interest rates payable are in accordance with the RBA’s indicator lending rates for banks;
- Limitations on the period of time that interest can be “fixed”;
- There is at least monthly principal and interest repayments;
- A registered mortgage over the property exists; and
- A written and executed loan agreement exists.
NOTE: The above is not an exhaustive list. Each asset and LRBA has unique features and circumstances. The above list is provided as a guide only and applies to real property (there are other guidelines for share parcels, for example). This should not be taken as a comprehensive legal advice as to what constitutes a commercial, arms length LRBA.
What About Prior to 30 June 2016?
PCG 2016/5 provides that the terms of existing or previous LRBAs will not be subject to further compliance action for the years ended 30 June 2015 or prior, if SMSF Trustee’s attend to the following prior to 30 June 2016:
- The LRBAs terms are consistent with arms length dealings; or
- The LRBA is brought to an end and the principal and interest payments are made under LRBA terms that are consistent with an arms’ length dealing; and
- SMSF Trustees have acted in good faith and revised the terms of existing LRBAs to ensure they comply with PCG 2016/5.
SMSF Trustees should immediately take steps towards reviewing LRBAs currently in place. If any inconsistency is identified between the LRBA and the guidelines outlined in PCG 2016/5, urgent action should be taken to address and restructure the LRBA. This action may include either altering the terms of the LRBA or refinancing the borrowing through a commercial lender or paying out the LRBA.
If you would like further information or advice in regard to self-managed superannuation funds, or if you require a review of your limited recourse borrowing agreements, please contact Tim Osborn on (02) 4927 2900.