Financial advisers with SMSF clients who have taken advantage of the limited recourse borrowing arrangement rules introduced in 2007, should check to see if the finance was provided by related parties. If so, trustees have until January 31, to get their house in order.
As is often the case when it comes to matters of income tax, as soon as a law is passed, especially one with as many holes and as badly drafted as the LRBA legislation, clever tax lawyers come up with ways of providing benefits that were not intended.
One of these was centred around a super fund borrowing from a related party, in other words from a member of the super fund or an associate of theirs, under favourable terms to the superannuation fund.
In practical compliance guideline 2016/5 the ATO has put all SMSF Trustees that have used loans from associated parties on notice. If the conditions of the loan do not meet what the ATO regards as acceptable conditions the trustees risk having the arrangement caught under the non-arm’s length income provisions with disastrous tax consequences.
On the other hand, if trustees take corrective action by January 31, 2017, the ATO will offer a safe harbour for super funds in this situation and will not take action against an SMSF, even though the previous loan terms did not meet the new guidelines.
To take advantage of the safe harbour provisions of this guideline trustees will have three options. The first is to alter the terms of the loan from a related party so it complies with arm’s length conditions, the second is to obtain finance from a commercial lender, and the third is to repay the loan to the related party.
The first thing to clarify is when a loan is regarded as being from a related party. Under the legislation, related parties include family members or entities that a family member or relative have an ownership stake in. A relative includes a parent, child, adopted child, grandparent, grandchild, sibling, great uncle, great aunt, niece, nephew, first cousin of the member, spouse or former spouse.
If the first option available is chosen, in other words alter the terms of the current loan, there are strict conditions that must be complied with. The first relates to the interest rate payable. To comply, the interest rate must be equal to the Reserve Bank’s indicator lending rates for banks providing standard variable housing loans to investors. For the 2015–16 year, this was 5.75 per cent.
The interest rate can either be variable or fixed. If it is decided to have a fixed rate, the period cannot exceed five years.
The term of the loan cannot exceed 15 years for both residential and commercial property. For existing LRBAs loans from related parties, the duration of the current loan counts towards the 15-year maximum. In other words, if the current loan has been in place for five years, the new loan can run only for 10 years.
There is also a maximum lending-to-value ratio of 70 per cent that must be complied with. The market value of the property must be established when the original or refinancing loan is entered into. For existing LRBA loans, the market value of the property at July 1, 2015, can be used.
The final requirements for a replacement loan to qualify under the safe harbour provisions are that there must be a registered mortgage over the property, there must be monthly repayments of principle and interest, and a written loan agreement must be drawn up.