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New SMSF ‘Safe Harbour’ guidelines

In October and November 2015 the ATO announced that they will be reviewing SMSFs from 1 June 2016. In particular, the ATO will focus on loans from related parties and non-commercial loans, including Limited Recourse Borrowing Arrangements (LRBAs).

At the time, Assistant Commission for Superannuation Kasey Mc Farlane confirmed that unless an LRBA is brought in line with the ATO’s requirements on or before 31 January 2017 then the ATO will potentially treat the loan as Non-Arm’s Length Income (NALI) for the SMSF.

SMSF income is normally taxed at 15% (or 0% to the extent the SMSF is in pension phase) but NALI is currently taxed at 47%. This change in approach therefore has the capacity to significantly worsen the tax position of SMSFs that engage in non-conforming LRBAs.

The ATO’s public position on NALI applying to LRBAs is set out in two interpretive decisions:

  • ATO ID 2015/27 Income tax: non arm’s length income – related party non-commercial limited recourse borrowing arrangement to acquire listed shares
  • ATO ID 2015/28 Income tax: non arm’s length income – related party non-commercial limited recourse borrowing arrangement to acquire real property

The ATO has also released Practical Compliance Guidelines, PCG 2016/5 (which can be accessed here) which sets out the ATO’s ‘safe harbour’ terms for LRBAs to constitute an arm’s length dealing.

The safe harbour terms are divided into two groups – one set for residential and commercial properties (including property used for primary production), and the other for collection of stock exchange listed shares or units.  The Guideline specifically do not cover LRBAs used to acquire unlisted or privately held shares or units.

Broadly, the following table summarises the key terms of the safe harbour for the two groups in accordance with the Guideline:

Guideline Safe Harbour 1 Safe Harbour 2
Type of asset acquired Real property – residential or commercial premises including property used for primary production Collection of stock exchange listed shares or units.
Interest Rate Reserve Bank of Australia (RBA) Indicator Lending Rates for banks providing standard variable housing loans for investors. RBA Indicator Lending Rates for banks providing standard variable housing loan for investor plus 2%.
Fixed or variable Fixed at rate at the commencement of arrangement up to 5 years or variable. Fixed at rate at the commencement of arrangement up to 3 years or variable.
Maximum Term of loan 15 years for original loan (any refinancing will be reduced by duration of the previous loan(s)). 7 years for original loan (any refinancing will be reduced by duration of the previous loan(s)).
Maximum Loan to Market Value Ratio (LVR) 70%.  The total amount of loans to acquire asset must not exceed 70% of the market value of asset when loan is entered. 50%.  The total amount of loans to acquire asset must not exceed 50% of the market value of asset when loan is entered.
Security Registered mortgage over the property is required. Registered charge or mortgage or similar security.  (eg. personal property security agreement).
Personal guarantee Not required Not required
Nature & Frequency of Repayments Each repayment is both principal and interest. Repayments are monthly. Each repayment is both principal and interest. Repayments are monthly.
Loan Agreement Written and executed loan agreement required. Written and executed loan agreement required.

The ATO has indicated that LRBAs structured in accordance with the ‘safe harbour’ guidelines by 31 January 2017 will be treated as arm’s length dealings, but that does not mean the NALI provisions will not apply for other reasons.

FWO strongly recommends that SMSF loans that do not satisfy all of the above criteria be reviewed before 31 January 2017 and, if appropriate, be amended to comply with the safe harbour guidelines. Alternatively, a SMSF trustee might choose to take other action to avoid the NALI provisions applying, such as rerefinancing the loan through a commercial lender or paying out the LRBA.

If you have any questions in relation to self-managed superannuation funds, limited recourse borrowing or the ATO’s new safe harbour principles, please contact FWO’s trusts and superannuation solicitor John Watson on 6650 7017.

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