The ATO has announced that it is allowing SMSF trustees additional time to ensure that any limited recourse borrowing arrangements (LRBAs) that their fund has are on terms consistent with an arm’s length dealing, or alternatively are brought to an end. The previously announced 30 June deadline has now been extended to 31 January 2017.
Why is the deadline being extended?
Since publishing their Practical Compliance Guideline PCG 2016/5 in April, the ATO has received a number of requests from SMSFs to allow them extra time, beyond 30 June 2016, to review the terms of their LRBAs to ensure that they are consistent with an arm’s length dealing.
The Practical Compliance Guideline PCG 2016/5 sets out the ‘safe harbour’ terms on which SMSF trustees may structure their limited recourse borrowing arrangements (LRBAs) consistent with an arm’s length dealing.
By the end of September the ATO will provide further information and illustrative examples to assist SMSF trustees and advisers to make decisions about relevant arrangements.
Due to the extension, the ATO say that they will not select an SMSF for an income tax review purely because it has an LRBA for the 2014-15 income years and prior, provided that:
- The SMSF trustee ensures that any LRBAs that their fund has is on terms consistent with and arm’s length dealing, or is alternatively brought to an end by 31 January 2017; and
- Payments of principal and interest for the year ended 30 June 2016 must be made under LRBA terms consistent with an arm’s length dealing by 31 January 2017
Key LRBA guidelines effective 31 January 2017
The PCG 2016/5 outlines the ‘safe harbour’ conditions for situations where a LRBA is used to purchase real property and where a LRBA is used to purchase a parcel of listed shares or units.
Key ‘safe harbour’ terms applying to the acquisition of real property through an LRBA include:
- Interest rates that align with the Reserve Bank of Australia’s Indicator Lending Rates for banks providing standard variable housing loans for investors
- Terms of loan agreement do not exceed 15 years with fixed interest rate loans not exceeding a period of a fixed rate for 5 years, and
- A Loan to Market Value Ratio not exceeding 70%
Key ‘safe harbour’ terms applying to the acquisition of a parcel of listed shares or units include:
- Interest rates that align with the Reserve Bank of Australia’s Indicator Lending Rates for banks providing standard variable housing loans for investors plus 2%
- Terms of loan agreement do not exceed 7 years with fixed interest rate loans not exceeding a period of a fixed rate for 3 years, and
- A Loan to Market Value Ratio not exceeding 50%
For SMSF trustees with LRBAs which do not meet the ‘safe harbour’ terms in PCG 2016/5 they cannot be assured that the Commissioner will accept the arrangement to be consistent with an arm’s length dealing. Trustees will need to be able to otherwise demonstrate that the LRBA was entered into and maintained on terms consistent with an arm’s length dealing, which may include evidence to show that the terms of the particular LRBA replicate the terms of a commercial loan that is available in the same circumstances.
Important notes and actions
The ATO will commence audits of SMSFs with LRBAs not financed by a bank and if they do not meet the Guidelines or terms consistent with arm’s length dealings on 1 January 2017.
Failure to comply with these provisions may result in the ATO determining that all the income derived under the LRBA is “non-arm’s length income” (“NALI”) and subject to tax at the top marginal rate.
We can assist SMSF trustees review PCG 2016/5 and assess whether their LRBAs are classified as arms-length. If they aren’t, we can assist them to assemble documentation or take other actions to avoid potential ATO compliance reviews for the 2014-15 and earlier income years.
We can also assist in the review, update and preparation of new LRBAs that comply with PCG 2016/5.
If you would like to discuss any of the above in further detail, please do not hesitate to contact us on (07) 3391 5055 or email firstname.lastname@example.org.
Disclaimer: This article contains general information only and is not intended to constitute financial product advice. Any information provided or conclusions made, whether express or implied, do not take into account the investment objectives, financial situation and particular needs of an investor. It should not be relied upon as a substitute for professional advice.