On 6 April 2016, the ATO issued Practical Compliance Guidelines PCG 2016/5 Income tax - arm's length terms for Limited Recourse Borrowing Arrangements established by self managed superannuation funds (Guideline) which:
- provides further guidance on how existing non-commercial limited recourse borrowing arrangement (LRBA) loans from related parties to self managed superannuation funds (SMSFs) can be put on commercial terms by 30 June 2016; and
- sets out 2 safe harbours for LRBA loans from related parties to SMSFs (one relating to the acquisition of real estate and the other relating to the acquisition of shares).
If a non-commercial LRBA loan exists, an SMSF will need to do one of the following by 30 June 2016 to ensure the non-arm’s length income rules are not triggered, resulting in non-arm’s length income being taxed at the highest marginal tax rate:
- bring the loan terms in line with the safe harbour terms under the Guideline with effect for the entire 2015/16 year (including that interest and principal for the 2015/16 year must be paid); or
- refinance the loan through a commercial lender (however, the loan must still be put on a commercial basis for the 2015/16 year – including the payment of interest and principal for that year up until the time of the refinancing of the loan); or
- repay the LRBA loan (however, again, the loan must still be put on a commercial basis for the 2015/16 year – including the payment of interest and principal for that year up until the time of the repayment).
The safe harbor terms are as follows:
1. In relation to LRBA loans used to acquire real estate:
- the interest rate must equal the Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors (currently 5.75%);
- have a term of no more than 15 years (5 years for a fixed interest rate) – variable interest rates reset each 1 July based on the rate in the previous May;
- have a loan to value ratio (LVR) of no more than 70%;
- have monthly payments of principal and interest; and
- be secured against real estate.
2. In relation to LRBA loans used to acquire listed shares, the safe harbour provisions are similar to the safe harbour for real estate except that:
- the interest rate is an additional 2% (currently 7.75%);
- the maximum term of the loan is 7 years (3 years for fixed interest); and
- the LVR is 50%.
Unfortunately, the ATO has not issued a safe harbour for other assets like investments in a regulation 13.22C trust or collectables. Such arrangements will need to be benchmarked against commercial rates.
Therefore, if an SMSF has an existing non-commercial LRBA loan from a related party, action must be taken prior to 30 June 2016 to ensure the loan is on commercial terms in accordance with the Guideline.
For more information or advice please contact: