ATO releases 'safe harbour' guidelines for certain superannuation borrowings

The ATO has released new guidelines to help self-managed super fund trustees ensure that their limited recourse borrowing arrangements do not attract the non-arm's length income provisions of the Income Tax Assessment Act 1997 (Cth).
 

Overview

Limited recourse borrowing arrangements (LRBAs) have become commonplace in self-managed super funds (SMSFs) in recent years, often involving SMSFs borrowing from related parties in order to fund acquisitions of properties and equities.

Such borrowings are permitted, provided they are maintained on arm's length terms. Failure to ensure arm's length terms can result in the fund's income from the arrangement being taxed at the highest marginal tax rate (see our earlier article on the non-arm's length income provisions).

The ATO's recently released guidelines set out 'Safe Harbour' terms which — for the purpose of income tax assessment and compliance purposes — the Tax Commissioner will accept as satisfying the requirement that the LRBA be on arm's length terms.

The guidelines apply to SMSF trustees who have established LRBAs that meet the requirements of superannuation law. [1]

Safe Harbour 1 — Where the asset acquired is real property

Safe Harbour 1 applies when an SMSF trustee uses an LRBA to acquire real property or to refinance a borrowing used to acquire real property. It applies whether that property is a residential or commercial premises. For the Safe Harbour to apply, the borrowing must reflect and be maintained on the following terms:

  • For variable interest rate loans (VIRL), the interest rate for the 2015—16 year is 5.75% and for 2016—17 and later years the rate published for May;
  • Fixed interest rate loans (FIRL) must be set by the trustee at the commencement of the arrangement for a specified period, up to a maximum of 5 years;
  • The loan term for original VIRL and refinanced VIRL is set at a 15-year maximum loan term. In the case of a refinanced loan, the duration of the loans being refinanced must be subtracted from the 15 year total;
  • A new LRBA set after the publication of the guidelines may involve a FIRL at the beginning of the arrangement; the rate may be fixed for a maximum of 5 years and must convert to a VIRL at the end of the 5-year period. The maximum term of the entire loan is also 15 years;
  • A current LRBA may adopt the 5.75% rate for its FIRL, provided the total fixed rate period does not exceed 5 years, and must convert to a VIRL at the end of the 5-year period for a total of a 15-year maximum period;
  • A loan-to-market value ratio (LVR) of 70% for both commercial and residential properties;
  • A registered mortgage over the property is required; however, personal guarantees are not; and
  • The loan agreement must be written and duly executed, and the repayments must be required and made, with monthly repayments of both principal and interest.

Safe Harbour 2 — Where the asset acquired is a collection of stock exchange-listed shares or units

Safe Harbour 2 applies when an SMSF uses an LRBA to:

  • acquire a collection of shares in a stock exchange-listed company;
  • acquire units in a stock exchange-listed unit trust; or
  • refinance a loan used to acquire such a collection.

The Commissioner will accept the LRBA as being consistent with an arm's length dealing provided the terms of the borrowing are established and maintained throughout the LRBA on the following terms:

  • VIRL is the same as Safe Harbour 1 plus an additional 2%, i.e. a total of 7.75% for the 2015—16 year. The same 2% addition applies to all later years;
  • FIRL can only fix for a maximum of 3 years, and the fixed rate is the rate for May plus 2%;
  • The loan terms under Safe Harbour 2 differ in maximums only, with an original or refinanced VIRL having a maximum term of 7 years and a FIRL having a maximum fixed period of 3 years (7 years in total);
  • Maximum LVR of 50%;
  • Safe Harbour 2 requires a registered charge/mortgage or similar security (that provides security for loans for such assets); however, it does not require personal guarantees; and
  • The loan agreement must be written and duly executed and the repayments must be monthly, repaying both principal and interest.

What about arrangements which do not reflect the Safe Harbour terms?

If the SMSF trustee has entered into an LRBA which does not satisfy the above 'Safe Harbour' terms set out in the guidelines, the trustee can have no assurance the Tax Commissioner will find the LRBA sufficient to avoid the non-arm's length income provisions. However, the guidelines make the point that failure to meet the safe harbour terms does not mean the LRBA is automatically deemed to not be on arm's length terms (as the guidelines are not laws, but rather the ATO's 'practical administration approach').

Amending the terms of an LRBA

SMSF trustees and their advisors:

  • should consider amending existing LRBAs to conform with the new Safe Harbour guidelines;
  • have until 30 June 2016 to do so; and
  • will require every party to any amended document to agree to the changes.

More information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Commercial team.

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a range of topics.

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[1] section 67A (or former subsection 67(4A) if applicable) of the Superannuation Industry (Supervision) Act 1993.