Newsletter:

Super News - SMSF Limited Recourse Borrowing Arrangements (LRBA)

29 August 2016

Shirley Schaefer, Partner, Superannuation |

A Self Managed Superannuation Fund (SMSF) is not prohibited from borrowing money to acquire an asset, providing the arrangement entered into satisfies the conditions specified under the Superannuation Industry (Supervision) Act 1993 (SISA).

Section 67A(1) of SISA provides an exemption from the basic prohibition on SMSF borrowing where:

  • The borrowing is applied for the acquisition of a single acquirable asset
  • The borrowing is to be used to purchase an asset that is held on trust for the SMSF
  • The SMSF must receive a beneficial interest and a right to acquire the legal ownership of the asset through the payment of instalments
  • The loan must be applied to an asset that the fund is permitted to acquire under the superannuation law
  • The lender’s right to recoup against the loan must be limited to recovery from the specific asset.

It is important to note that separate arrangements are required for each asset acquired. For example: the purchase of land, or land with a house, will meet the definition of a single acquirable asset; however the existence of multiple titles may suggest that the property is not a single asset. Where the asset is considered to be multiple assets, separate Limited Recourse Borrowing Arrangements (LRBA’s) will be needed for each asset. Where there is legal or physical impediment to the asset that prevents the different titles from being sold separately, the multiple parcels will constitute a single asset.

The diagram below illustrates a LRBA structure for the purchase of property (using a bank as financier):

Related Party Borrowings

It is important to note, that the legislative restrictions do not apply to those who the SMSF borrows money from. While many LRBAs are established using a bank or other public financier as the lender, it is possible for a SMSF to borrow money from the member or a related party under an LRBA structure.

Over the past few years, there has been significant discussion, and media and regulator commentary around related party LRBAs, particularly where the terms and conditions of the LRBA may not match those available from public lenders such as banks. The idea of ‘zero interest rate’ loans became popular and the ATO did not originally announce a position against these loans.

However, the regulator’s view has now changed and the ATO has issued guidance for SMSF trustees when entering into a LRBA with a related party (or the member) as the lender.

Practical Compliance Guideline 2016/5

The ATO has taken the view that the Non-Arm’s Length Income (NALI) provisions in ITAA 1997 can apply when a SMSF trustee undertakes LRBAs that aren’t financed through a bank or financial institution.

Income that is deemed to be NALI is taxed in the SMSF at the top marginal tax rate (including where the SMSF is in pension phase). This represents a significant tax penalty for non-compliance.
In the past, there has been confusion as to whether these LRBAs have been set up on inconsistent commercial terms (such as a 0% interest rate) and represent an arm’s length dealing. The ATO has released a ‘Practical Compliance Guideline’ detailing interest rates, loan to value ratio’s and other terms that constitute save harbours for SMSF LRBA’s so that arrangements will be taken to be consistent with an arm’s length dealing. The guide outlines the ‘Safe Harbour’ terms on which SMSF trustees are now required to structure their LRBAs consistent with an arm’s length dealing, so that the NALI provisions won’t apply.

The Safe Harbour guidelines do have different terms depending on the nature of the asset being acquired under the LRBA. The guidelines only relate to LRBAs where the acquired asset is real estate or listed shares or securities.

The Safe Harbour parameters are:

  REAL PROPERTY LISTED SECURITIES
Interest Rate RBA Indicator Lending Rates for investors (2015-16 year = 5.75%) RBA Indicator Lending Rates for investors + margin of 2%(7.75% for 2015/16)
Interest Can be fixed or variable Can be fixed or variable
Term of Loan 15 years 7 years
Loan to Value Ratio (LVR) Maximum Total LVR = 70% Maximum Total LVR = 50%
Security A registered mortgage A registered charge/mortgage or similar security
Nature & frequency of repayments Principal & Interest – at least monthly Principal & interest – at least monthly
Loan Agreement A written & executed loan agreement is required A written & executed loan agreement is required

Compliance with the Safe Harbour guidelines above, will ensure that the ATO will not treat any income arising from a related party LRBA as NALI, and applying the top marginal tax rate to the income from the arrangement.

When must the LRBA comply by?

The Safe Harbour rules apply both to existing LRBAs and those established from now on.

This concession is conditional on SMSF trustees ensuring that all existing LRBAs are on consistent terms with the new Safe Harbour terms by 31 January 2017.

Most importantly, payments of principal and interest for the year ended 30 June 2016, and up to 31 January 2017, must be also be brought up to date in line with the new requirements.

LRBA arrangements that are not within the Safe Harbour guidelines are not automatically deemed to be ‘non-commercial’. However, the burden of proof will be on the trustees of the SMSF to be able to show that an arrangement is commercial, and has been established on an arm’s length basis.

To summarise, all existing LRBA’s with related party loans have the following options:

Option1: Ensure terms of the related party loan comply with the ATO’s Safe Harbour guidelines by 31 January 2017 (including making interest and principal repayments consistent with an arm’s length loan for the year end 30 June 2016 and period ended 31 January 2017);

Option 2: Repay the related party loan in full, by either selling the asset or paying out the debt and transferring the asset into the SMSF, ensuring interest and repayments are consistent with an arm’s length loan for year end 30 June 2016 and period ending 31 January 2017;

Option 3: Have documentary evidence that the LRBA related party loan terms are equivalent to a commercial lenders terms, or some other evidence to support that the SMSF’s LRBA is ‘commercial’ and on arm’s length terms.

In the view of the ATO Safe Harbours, we strongly recommend that a review be undertaken of every LRBA that is not financed by a bank as soon as practical.

For further information please contact your BDO adviser or a member of the BDO Superannuation Team.