ATO’s “moveable feast” spawns SMSF headaches

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The Australian Taxation Office needs to fulfil its duty to taxpayers and clarify the rules surrounding limited recourse borrowing arrangements (LRBA) related party loans for SMSFs.

This is according to Townsends Business & Corporate Lawyers, who say the ATO’s expectations are a “moveable feast”.

Brian Hor, special counsel of superannuation and estate planning, told Wealth Professional that a number of private binding rulings released by the ATO could foreshadow dire tax implications for LRBA related party loans if they are found to have uncommercial loan terms.

The bone of contention is that the ATO have taken a relaxed approach to such arrangements in the past and haven’t set any clear boundaries, said Hor.

“Where the uncertainty has crept in is exactly what you can have in terms of these loans. Of late the tax office has been looking at what sort of interest rates have been charged on the loans, but in past rulings its said its ok if the interest rate is 0% and even if the parties are related,” he said.

The real issue seems to be if the tax office thinks that the result of the arrangement means that the fund would receive income that’s more than what could be expected from an arms-length fund.

This would then be treated as “special income”, and it would be taxed at the top rate of 45%.

“But in the past there have been other rulings where these various aspects have been deemed to be ok, so there’s inconsistency and it’s quite unnerving for advisers and their clients,” Hor said. “We’ve said, ‘well when does a loan become a special income loan’, and they’ve said ‘it depends’. We’re all scratching our heads.”

The ATO has indicated the following features of related party loans are among criteria that may result in the application of special income taxation to the LRBA:
  • Uncommercial loan to value ratio
  • Unsecured loans
  • Zero or below-market interest rates
  • Unspecified or particularly lengthy loan periods
It seems that the use of one or more of these terms in conjunction with commercial terms may not necessarily result in the SMSF needing to pay special income taxation, but that’s not concrete and is determined on a case-by-case basis.

Hor said the safest bet is to mimic commercial lender terms with any LRBA related party loans, prudency that Townsends Business & Corporate Lawyers have always advised.

And those who have current related party loans in place where the income could be considered non-arm’s length should look at amending the non-commercial aspects as soon as possible, he said.

Rather than taking a broad view of the LBRA related party loans, the ATO has made the mistake of nit-picking different technical aspects of them over time, resulting in unpredictable rulings, Hor said.

“But clarity of law is one of the basics in a legal system – it’s absolutely critical – and frankly I think the ATO has breached its duty to us as taxpayers to not make this clear.”

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