Lawyers are warning there is a new danger for SMSFs
with zero interest related party loans.
A number of recent private binding rulings released by the Australian Tax Office to do with limited recourse borrowing arrangements (LRBA) related party loans appear to have dire tax implications if they are found to have uncommercial loan terms, Townsends Lawyers warns.
Of most concern is the ATO’s warning that income generated from a LRBA may be considered as ‘non-arm’s length income’ if the terms of the loan are 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.
There are tax implications to such a decision.
By deeming the income from such arrangements to be special income, a significant tax rate of 45% – plus possibly the new high earners ‘levy’ – would be applied to all rental income, dividends, interest and capital gains or losses derived from the asset, the lawyers said.
This has the potential for 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.
The following features of related party loans may result in special income taxation to the LRBA:
1. Uncommercial loan to value ratio
2. Unsecured loans
3. Zero or below-market interest rates
4. Unspecified or particularly lengthy loan periods.
However, the ATO has indicated it takes a holistic view of the loan arrangement and the use of one (or possibly more) of these terms in conjunction with other commercial terms may not necessarily result in the SMSF having to pay special income taxation on the derived income.
Townsends Lawyers said it would be prudent to make sure any related party loans are on commercial terms.
“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,” said special counsel Brian Hor.
“For those who have current related party loans in place and are concerned with the derived income being determined as non-arm’s length income, it may be wise to review the current loan terms and consider whether these should be varied to ensure they are indeed at arm’s length and commercial.”
With the increased penalty regime of the ATO starting on 1 July, the lawyers recommend these types of loans are reviewed immediately, as the ATO can impose a fine for non-compliance after that date.