Australia: SMSFs beware - Are your related party borrowings at arm's length?

The Australian Taxation Office (ATO) has, on a number of occasions, expressed the view that the non-arm's length provisions of the Income Tax Assessment Act 1997 (Cth) (s 295-550) can apply when an SMSF trustee enters into or maintains limited recourse borrowing arrangements (LRBAs) that are inconsistent with an arm's length dealing. This view was set out in ATO interpretative decisions ATO ID 2015/27 and ATO ID 2015/28.

Until recently, there were various uncertainties around related party LRBAs but we now know that related party LRBAs should be fully reflective of arm's length terms, and those terms must be complied with on an ongoing basis.

The ATO is now urging SMSF trustees to review any non-commercial LRBAs and amend their loan terms in line with benchmark evidence. However, this amnesty isn't open-ended so SMSF trustees will need to get their house in order by 30 June, 2016.

We recommend that SMSF trustees promptly review any related party LRBA to determine whether the terms of the loan are on the same terms that would be agreed with an arm's length lender. In practical terms, this means establishing whether a bank will lend and on what terms they will lend, and gathering appropriate evidence to support the terms of their arrangements. Suffice to say, favourable loan terms such as 0% (or low interest), high loan to security value ratios or unusual repayment terms are unlikely to stand up to the ATO's scrutiny.

Although the ATO will not be dedicating compliance resources to review a SMSF's LRBA until 1 July 2016, SMSF trustees would be well advised not to sit on their laurels as they risk the fund's income being taxed at the highest marginal rate of 47% if a non-commercial LRBA is uncovered by the ATO in the meantime.

If you have any doubt about whether your fund's LRBA is on arm's length terms, you should seek professional advice and if necessary, adjust the terms of the loan (and continually monitor compliance with those terms) to reflect an arm's length arrangement, or perhaps take steps to refinance the loan by 30 June, 2016.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.