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28/04/2016 | Stephen Harvey NALI, LRBA, PCG, SuperDepot

Stop The Presses

Urgent update on NALI and related party loans
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We have written previously on limited recourse borrowing arrangements involving related party loans, in our articles ATO to clarify related party loans and LRBAs and 30 June 2016 Deadline. The ATO released in April a guidance that provides clarity around the terms that the ATO will accept as arm's length.

It's fair to say that, since the release of ATO ID 2015/27 and 2015/28 in late 2015, there has been a great deal of uncertainty surrounding the nature of terms which the ATO considers to be commercial arm's length for the purposes of a related party loan. The harshness of the application of the views in the ATO's announcements, for non-arm's length income (NALI) purposes, led to the release of Practical Compliance Guidance 2016/5 (PCG) on 6 April 2016. The guidance provides a safe harbour for related party loans, provided they meet the minimum terms set out in the PCG.

Paragraph 2 of the PCG states:

  1. This Guideline sets out the 'Safe Harbour' terms on which SMSF trustees may structure their LRBAs consistent with an arm's length dealing. That is, for income tax compliance purposes, the Commissioner accepts that an LRBA structured in accordance with this Guideline is consistent with an arm's length dealing and that the NALI provisions do not apply purely because of the terms of the borrowing arrangement.

It is clear from this statement that the ATO will consider all of the circumstances surrounding a related party LRBA, and not only the terms of the loan itself. Accordingly, related party loans that meet the minimum requirements in the PCG will, generally, be entitled to the safe harbour. Other characteristics, however, of the arrangement may yet result in NALI.

Clearly all dealings other than the loan terms must, therefore, be arm's length and all other requirements of SIS must also be met. For example, a related party loan arrangement that breaches the sole purpose test may not be entitled to rely on the safe harbour alone, to avoid NALI. For example, setting an interest rate higher than the acceptable commercial arm's length rate may breach the sole purpose test since the related party lender will be receiving a benefit on other than arm's length terms.

Paragraph 4 of the PCG also goes on to say:

  1. If SMSF trustees have entered into an arrangement which does not meet all of the 'Safe Harbour' terms set out in this Guideline, whilst the trustees are unable to be assured that the Commissioner will accept the arrangement to be consistent with an arms' length dealing, it does not mean that the arrangement is deemed not to be on arms' length terms. It merely means that there is no certainty provided under this Guideline. The trustees will need to be able to otherwise demonstrate that the arrangement was entered into and maintained on terms consistent with an arms' length dealing. One example of how a trustee may demonstrate this is by maintaining evidence that shows their particular arrangement is established and maintained on terms that replicate the terms of a commercial loan that is available in the same circumstances.

This means that the ATO will accept terms other than those set out in the PCG, but that it is then incumbent upon the trustee of the Fund to satisfy the ATO that those loan terms are, in fact, commercial arm's length.

Interestingly, while the PCG deals with property and listed securities, it does not answer other critical questions. These include what commercial arm's length terms might look like where the asset acquired is, for example, a collection of units in an unlisted property trust.

For the purposes of the PCG, the safe harbour loan terms for LRBAs used to acquire real property are:

Interest Rate

The Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors.

For the 2015-16 year, the interest rate is 5.75%.

For the 2016-17 and later years, the rate published for May (the rate for the May before the relevant financial year).

Fixed / variable

The interest rate may be variable or fixed.

Variable - uses the applicable rate (as set out above) for each year of the LBRA.

Fixed - trustees may choose to fix the rate at the commencement of the arrangement for a specified period, up to a maximum of 5 years. The fixed rate is the rate for the May before the relevant financial year.

Term of Loan

Variable interest rate loan (original) - a 15 year maximum loan term. Fixed interest rate loan - a new LRBA may involve a loan that has a fixed interest rate set at the beginning of the arrangement. The rate may be fixed up to for a maximum of 5 years, and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 15 years.

LVR

Maximum 70% LVR.

If more than one loan is taken out to acquire (or refinance) the property, the total amount of all those loans must not exceed 70% LVR.

The market value of the property is to be established when the loan (original or re-financing) is entered into.

Security

A registered mortgage over the property is required.

Personal guarantee

Not required.

Nature & frequency of repayments

Each repayment must be of principal and interest. Repayments must be made monthly.

Loan agreement

A written and executed loan agreement is required.

For the purposes of the PCG, the safe harbour loan terms for LRBAs used to acquire collection of stock exchange listed shares or units are:

Interest Rate

The Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors plus 2%.

For the 2015-16 year, the interest rate is 5.75% + 2% = 7.75%.

For the 2016-17 and later years, the rate published for May plus 2% (the rate for the May before the relevant financial year).

Fixed / variable

The interest rate may be variable or fixed.

Variable - uses the applicable rate (as set out above) for each year of the LBRA.

Fixed - trustees may choose to fix the rate at the commencement of the arrangement for a specified period, up to a maximum of 3 years. The fixed rate is the rate for the May before the relevant financial year plus 2%.

Term of Loan

Variable interest rate loan (original) - a 7 year maximum loan term.

Fixed interest rate loan - a new LRBA may involve a loan that has a fixed interest rate set at the beginning of the arrangement. The rate may be fixed up to for a maximum of 3 years, and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 7 years.

LVR

Maximum 50% LVR.

If more than one loan is taken out to acquire (or refinance) the collection of assets, the total amount of all those loans must not exceed 50% LVR.

The market value of the collection of assets is to be established when the loan (original or re-financing) is entered into.

Security

A registered charge or similar security (that provides security for loans for such assets) is required.

Personal guarantee

Not required.

Nature & frequency of repayments

Each repayment must be of principal and interest. Repayments must be made monthly.

Loan agreement

A written and executed loan agreement is required.

Please contact us if you have any questions on these updates in the lead up to June 30.