A Sydney business lawyer is warning mortgage brokers to be careful on behalf of clients who want to buy property through their self-managed super fund.
A number of recent private binding rulings released by the Australian Tax Office on limited recourse borrowing arrangements (LRBA
) related party loans, show there are dire tax implications if the arrangement is found to have uncommercial loan terms.
Particularly concerning is the ATO’s warning that income generated from a LRBA
may be considered as ‘non-arm’s length’ income if the loan terms result in a greater amount of returns to the SMSF
than what might otherwise be expected if it was dealing with a lender at arm’s length, warned Peter Townsend, principal of Townsends Business and Corporate Lawyers.
“By deeming the income from such arrangements to be special income, a significant tax rate of 45% would be applied to all rental income, dividends, interest and capital gains or losses derived from the asset.
“Accordingly, this has the potential to result in a significant tax bill for the SMSF
and potentially calls into question whether the trustees have acted in the best interest of the members by entering into such a loan agreement,” he said.
Features of related party loans which may cause special income tax to be applied to the LRBA
include uncommercial loan to value ratio, unsecured loans, zero or below-market interest rates and unspecified or particularly lengthy loan periods, Townsend said.
However, what combination of these terms would be approved by the ATO seems to only be determined on a case by case basis at the moment and no further guidance has been provided.
As a result, it would be prudent to make sure any related party loans are on commercial terms, Townsend said.
“We often suggest that for clients mimicking commercial lender terms that they keep documentation – for example lender’s brochure, website print out, loan offers –demonstrating these terms, to provide to an auditor or the ATO in the future.”
For clients who have current related party loans in place and are concerned that derived income may be categorised as non-arm’s length income, it “may be wise” to review the current loan terms and consider whether these should be varied to make sure they are at arm’s length and commercial, Townsend said.
“With the increased penalty regime of the ATO starting on 1 July, 2014 it would be appropriate to review these loans before the starting date, as the ability of the ATO to impose a fine will apply to existing non-compliance after that date.”
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