I have discussed previously the issues the ATO has with non-arm’s length limited recourse borrowing arrangements (LRBA’s).
They fall into two main categories:
- Non-market lending arrangements favouring the Lender.
Consequences: Beach of section 109 which may lead to fines, penalties and loss of complying fund status
- Non-market lending arrangements favouring the Fund.
Consequences: Top marginal tax rate payable on income and capital gains earned on the underlying investment (even if in pension phase).
- Loan to value ratio (LVR).
- Interest rate charged.
- Repayment period.
- Repayment terms.
- Security given.
I strongly recommend that you review all client related party LRBA’s and seek advice to amend the loan agreement where its market value nature is questionable.
Our friends at the ATO appear to have extended leniency till the 30 June 2016 for Trustees to make necessary changes to ensure “it is on terms consistent with an arm’s length dealing”.
I have come across many LRBA’s that are bordering on non-market and chances are you have a client in a similar position. Take advantage of this rare concession.
Joel Curry, is Director of TriSuper Auditors. He has personally audited in excess of 8,000 individual SMSFs, and is ranked within the top 4% of all auditors nationwide as recognised by the ATO.
What is a related-party?
In order to maintain the sole purpose test of superannuation funds (which is to provide death or retirement benefits to members or the members’ dependants) the Australian Taxation Office (ATO) imposes a number of investment restrictions on transactions involving ‘related parties’ of an SMSF and ‘relatives of members’.
Essentially, a related party includes:
- All members of the SMSF
- All relatives of each SMSF member (this extends to parents, grandparents, brothers, sisters, uncles and aunts, nephews and nieces, lineal descendant or adopted child of the member or their spouse)
- All business partners of SMSF members, as well as the immediate family members of the business partners
- Any company a member or their associates control or influence and any trust the member or their associates control
- Employer-sponsors and associates of employer-sponsors
What is a limited recourse borrowing arrangement (LRBA)?
LRBAs allow SMSFs to borrow money to buy a single asset as long as the lender’s recourse is limited to that asset only if the SMSF defaults on the loan. In other words, the lender’s recourse is limited.
The ATO provides the following explanation:
“An LRBA requires an SMSF trustee to take out a loan from a third party lender. The trustee then uses those funds to purchase a single asset (or collection of identical assets that have the same market value) to be held in a separate trust.
Any investment returns earned from the asset go to the SMSF trustee.
If the loan defaults, the lender’s rights are limited to the asset held in the separate trust. This means there is no recourse to the other assets held in the SMSF.”