Amnesty on related party LRBAs

It is not uncommon for a related party to make a loan to a SMSF trustee to purchase a ‘single acquirable asset’ in accordance with section 67A of the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA). The terms of such a loan, however, have been a vexed matter. It is trite to state that the borrowing provisions under the SISA do not provide any guidance as to the terms of the loan, other than requiring the loan to be limited recourse, such that the rights of the lender (or any other entity) as against the SMSF trustee are limited to rights relating to the asset acquired with the borrowing.

Thus there has been considerable uncertainty and varying industry views as to whether ‘uncommercial’ terms would result in tax or superannuation law consequences.

Amnesty on related party LRBAs The position has now been clarifi ed as the ATO have confirmed its view that the non-arm’s length income (NALI) provisions in section 295-550 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) may apply to LRBAs.

In a stroke of pragmatism, the ATO confirmed at a meeting of the Superannuation Industry Relationship Network on 10 November 2015 that a temporary ‘amnesty’ will operate to allow trustees the opportunity to review and amend related party loans that are not strictly arm’s length dealings. In particular, the ATO will not require related party LRBAs that are not on arm’s length terms to be retrospectively adjusted, subject to the loan terms being amended prospectively.

The ATO has noted, however, that compliance resources are likely to be allocated to reviewing LRBAs from 1 July 2016 onwards. However, if an officer discovers an uncommercial LRBA through usual audit

activity in the meantime, the SMSF’s income relating to the LRBA is likely to be taxed as NALI.

Similarly, the ATO have confirmed that if required to take a formal position in relation to an uncommercial LRBA ie. in a litigious situation or private ruling context, the ATO will adopt an approach consistent with ATO ID 2015/27 and ATO ID 2015/28.

Thus trustees would be prudent to put existing LRBAs on arm’s length terms as soon as possible to avoid the SMSF’s income relating to the LRBA being taxed at the non-concessional rate applying to NALI.

Background

The ATO confirmed in ATO ID 201/162 that a nil interest loan would not contravene section 109 of the SISA, as the arrangement was no more favourable to the lender than would apply if the parties were dealing on arm’s length terms.

ATO ID 2010/162, however, only considered this particularly narrow aspect of the superannuation law.

As a result, a number of related parties entered into nil interest (or low interest) loans in connection with LRBAs.

Following a number of private rulings, the ATO released ATO ID 2015/27 and ATO ID 2015/28, which confirm that in certain circumstances, the NALI provisions may apply to income derived from an LRBA.

While fact specific, ATO ID 2015/27 and ATO ID 2015/28 provide persuasive guidance as to how the commissioner is likely to apply the NALI provisions in an LRBA context where similar facts exist.

To illustrate this point, the key facts of ATO ID 2015/27 for present purposes are

as follows:

• a loan of several million dollars was repayable as a single lump sum at the end of the loan term, or earlier as agreed between the parties; the loan term was 20 years

• the interest rate on the loan was nil, or such other rate as agreed between the parties from time to time

• a first ranking mortgage in favour of the lender was granted over the assets acquired with the borrowed amount; no personal guarantees or other security was provided

• the amount borrowed was 100 per cent of the value of the assets to be acquired and held for the benefit of the SMSF.

In light of the circumstances outlined above, the commissioner formed the view that the arrangement gave rise to NALI on the basis that:

• the lender was not compensated for the opportunity cost in lending the principal or for the risk regarding the limited recourse nature of the loan and lack of other

• security, such as personal guarantees only a single lump repayment at the end of the (substantial) loan term was required

• the LVR was 100 per cent, particularly given the nature of the assets to be acquired and the limited recourse nature of the loans

• the income the trustee might be expected to derive was nil on the basis that an arm’s length party would not lend on the terms set out above.

Next steps

Trustees should review any related party LRBAs to determine whether they were established and maintained on terms that are consistent with an arm’s length dealing. Favourable loan terms that may suggest that a related party loan is not on an arm’s length basis include:

• loans with 0 per cent or low non-commercial interest

• high loan-to-value ratios

• single lump sum repayment at the end of the loan term rather than regular periodic repayments.

If there is any doubt in this matter, the terms of the loan should be renegotiated between the parties to ensure the loan terms are consistent with ordinary commercial practice as soon as possible and in any event by 30 June 2016.

Keep in mind, however, that any variation to the loan terms should be permitted by the existing loan agreement and drafted in such a way that they comply with the borrowing provisions in section 67A of the SISA. DBA Lawyers can assist in documenting the variation to the loan term to ensure it is drafted in a manner that does not contravene superannuation law.

Importantly, the loan agreement should reflect a process of real bargaining between the parties and stand up to ATO scrutiny. Thus proper benchmarking is crucial. In practical terms this means approaching a number of unrelated lenders and comparing the loan terms they would offer to the SMSF

in the particular scenario, and then ensuring that the related party loan mirrors the terms offered by the unrelated lenders.

While the ATO are yet to define a ‘safe harbour’ it is certainly prudent to mitigate the risks by having well-documented ‘benchmark’ evidence to indicate arm’s length terms and conditions.

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.