The Australian Taxation Office (ATO) has issued a private binding ruling 1012582301006 suggesting that a favourable limited recourse borrowing arrangement by a self-managed superannuation fund (SMSF) from a related party may give rise to significant adverse tax implications.
What follows is an overview of the ATO position with respect to structuring non-arm’s length SMSF borrowing arrangements and its implications.
A related party loan subject to the concerns of the ATO may have any one of the following features:
- the loan amounting to 100% of the value of the assets to be acquired; or
- 0% interest rate; or
- a term of the loan repayment up to several decades; or
- no personal guarantees required; or
- repayment the loan as a single lump sum at the end of the loan term.
The ATO is of the view that such features are not arm’s length dealings. Not surprisingly the ATO has indicated that the income derived by the SMSF from such a loan would be non-arm’s length income. Accordingly, the income would be taxed at 45%!
The ATO’s reasoning was based on the fact that the amount of income derived by the SMSF as a beneficiary of the limited recourse borrowing arrangement in question would be more than the amount that the SMSF might have been expected to derive if the parties had been dealing with each other at arm’s length for the purposes of section 295-550(5) of the Income Tax Assessment Act 1997 (Cth).
Though there are no other recent publicly available private binding rulings considering nil interest loans on less extreme terms, extreme caution should be used. The warning of the ATO is that income from a limited recourse borrowing arrangement may be considered as non-arm’s length income of a SMSF if the loan results in a greater amount of returns to the SMSF than the returns that may otherwise be expected from a dealing with a lender at arm’s length, for example a less than 100% loan-to-value ratio or a low-interest rate limited recourse borrowing by SMSF.
Furthermore, the ATO private binding rulings are not public rulings and are to be relied on only by the specific taxpayers referenced in any particular tax ruling. However, a private ruling provides insight into the ATO’s application of any particular tax law subject to the ruling.
If you have a related party loan that may be on favourable terms within your SMFS, such a loan may need review. Some extremely favourable limited recourse borrowing arrangements may require amendment of their terms. Others may need a different solution.
Should you require advice or assistance with respect to existing or contemplated limited recourse borrowing within your SMSF, assistance with the governing deed of your SMSF, advice with respect to fund trustees obligations or on other aspects of superannuation law, please contact our Superannuation Lawyers Sydney.