Should you reconsider your existing lending agreements?
There have been changes made to the rules of how Self-Managed Super Fund’s (SMSF) can borrow from related parties. Since these changes were introduced earlier in the year we have seen a lot of talk about this topic and areas within the market which may have been awaiting for a clear and concise answer regarding this.
It is commonplace within SMSF’s to borrow in order to fund asset purchases, generally when investment property is being purchased within the fund. In most instances it is the bank or lending provider who supplies the majority of funding, with the deposit or portion of the total asset value being financed via rollovers or cash benefits within the SMSF.
The ATO has earlier this year issued the ‘Practical Compliance Guideline 2016/5’ to clarify and assist trustees of SMSF’s in structuring limited recourse borrowing arrangements (LRBAs), where the borrowing is provided by a related party. These guidelines set out the acceptable terms surrounding related party borrowing. A related party can be a member of the fund, or a relative or associate of one of the fund’s members or trustees. The ATO had previously implied that when a related party lends money to an SMSF, there was no requirement for a commercial, that is, market interest rate. The Australian Tax Office (ATO) is understood to have introduced these changes to ensure SMSF members are not given an unfair advantage compared to other investors.
The guidelines have been released to give a more definitive outline of what is considered to be acceptable for SMSF borrowing. Where a Limited Recourse Borrowing Arrangement (LRBA) with a related party lender is established and the loan is not on commercial terms, the ATO may classify the income from the arrangement as non-arm’s length income, which is subject to tax at the highest marginal rate. The guideline sets out the terms on which SMSF trustees may structure their LRBAs so that the ATO will accept the LRBA as being an arm’s length dealing.
The ATO’s guidelines have removed the uncertainty for trustees. Any SMSF loan that complies with the guidelines is considered to be on commercial terms. The following is an example of SMSF loan provisions which are required to be met for it to meet the guidelines discussed:
|Loan Condition||Real Property LRBA||Listed shares or units LRBA|
|Interest rate||RBA standard variable housing loan for investors 5.75% for 2015/16||RBA standard variable housing loans for investors + 2%7.75% for 2015/16|
|Term of loan||Maximum 15 years (including expired periods)||Maximum 7 years (including expired periods)|
|LVR||Maximum 70% (aggregate of all loans)||Maximum 50% (aggregate of all loans)|
|Security||Registered mortgage||Registered charge|
|Personal Guarantees||Not required||Not required|
|Type of repayment||Principal & interest||Principal & interest|
|Frequency of repayment||Monthly||Monthly|
Some key factors from the above table are:
- The interest rate can be fixed, but only for 5 years where the asset under the LRBA is property and 3 years for listed shares or units in a fixed trust;
- If the loan is re-financed with another related party loan then the term of the re-financed loan must take into account the term of the original loan. For example, a related party loan commenced 1 July 2011 and is re-financed on 1 July 2016 with a new related party loan. The asset acquired with the original loan monies was real property. The maximum term of the re-financed related party loan is 10 years, which would be the same remaining term if the original loan was not re-financed, but simply amended to the ‘safe harbour’ guidelines. Re-financing to another related party loan does not re-start the term;
- The LVR of 70% for real property LRBAs and 50% for listed shares or units LRBAs is an aggregate for all related party loans;
- Repayments must be on a principal and interest basis. To comply with these safe harbour guidelines, there can be no interest only loans;
- Repayments must be made on a monthly basis, not any other basis, e.g. quarterly;
- To satisfy the requirement for loan to be secured, for non-property arrangements, use the Personal Property Securities Register.
For those SMSF’s with existing related party loans, the ATO has extended the deadline for complying with the released guidelines until 31 January 2017. Should you not be able to update your existing loan arrangements, alternatively, you can refinance the debt with a bank, or repay the existing debt.
This timeframe is quite soon approaching and we highly encourage that if you are in a situation where a related party loan is being utilised that you commence work to rectify and update your SMSF lending situation to ensure it complies with the latest guidelines.
We should note that trustees may enter into an LRBA that is inconsistent with the guidelines, however, they must demonstrate that the arrangement was entered into and maintained between all the parties on terms consistent with an arm’s length dealing. This may be completed by the use of replicating the terms of a commercial loan for which is available for a similar set of circumstances and situation.
Those of you (trustees) who are considering or looking at the option of buying a property with a related party loan in the future should ensure that the terms of the loan conform with the safe harbour guidelines. We offer a wide ranges of services including financial planning, superannuation administration and SMSF accounting. If you wish to speak with us regarding any of these areas or wishing to speak to one of our mortgage broking referrals to discuss what options you have available for now and the future, contact us [Total Advice Partners on (07) 3284 7875] so we may assist you in this area of advice.