The ATO recently published 2 new interpretative decisions concerning related party limited recourse borrowing arrangements and non-arm's length income.
One feature common to the decisions was the 0% interest rate applying under the relevant loan arrangements. In these circumstances, the ATO determined that all income derived by the SMSF was to be assessed as non-arm's length income, currently subject to a 47% tax rate.
This article briefly summarises the ATO's decisions and explains the practical considerations for members and trustees of SMSFs.Steven Tang, Maddocks Lawyers
Under the fact scenarios in each of ATO interpretative decisions ATO ID 2014/40 and ATO ID 2014/39 (the Decisions), the Commissioner of Taxation (Commissioner) considered:
Consequently, all of the income derived from the relevant asset acquired under each LRBA was considered non-arm's length income. Notably, non-arm's length income is taxable at the top marginal rate, currently 47%, regardless of whether the fund is paying a pension.
In each of the Decisions, the relevant facts included:
ATO ID 2014/39 — Investment in listed shares
In ATO ID 2014/39, which considered a borrowing arrangement used to acquire shares in ASX listed companies, the following additional facts were relevant:
ATO ID 2014/40 — Investment in commercial real property
In contrast, in ATO ID 2014/40:
The Decisions deal with 2 sets of facts which both involved interest free loans. However, both Decisions also involved other circumstances which contributed to the Commissioner determining, holistically, that the parties were not dealing with each other on an arm's length basis.
It is not clear whether the Commissioner would ever accept an interest free loan as being made on arm's length terms, nor the weight that the Commissioner will apply to each of the factors that comprise a borrowing arrangement, such as loan term, guarantees and repayment schedules.
Until such time as the ATO publishes guidance as to the factors the Commissioner will consider relevant when assessing whether an LRBA is entered on arm's length terms, fund trustees and members should consider the following and seek advice as needs be:
We do not think so.
In each of the Decisions, the Commissioner has adjudged that the correct comparison for the purposes of determining the amount of non-arm's length income, is between:
The Commissioner's Alternative Hypothesis is that in the factual circumstances set out in the Decisions, the arrangement would never have been entered into. That is, the lender would never have made the loan, the property would not have been purchased and the fund would not have received income from the Holding Trust.
The Commissioner relies on a 2011 Full Federal Court decision (Allen's Case) as authority for this proposition. However, Allen's Case was a case where special income was originally sourced from a distribution from a related discretionary trust. In such a case, the Court found that what 'might have been expected to apply' if the parties had been dealing at arm's length, is that no distribution would have been made to the superannuation fund. It is difficult to see such an approach being taken in these instances, as what 'might have been expected to apply' if the parties had been dealing at arm's length is that the terms of the arrangement would have been varied to reflect arm's length terms.
Arguably, if the parties were dealing at arm's length, then the interest rate and/or the security terms would have been varied. Importantly, however, the transaction would have proceeded otherwise unaltered. Having said that, it needs to be noted that what 'might have been expected to apply' depends on the individual circumstances of each proposed transaction.
If our submission in response to the Alternative Hypothesis is correct, then the non-arm's length income would be no greater than the actual arrangement. This is because:
But what about the additional interest expense? Remember that the interest expense is met from the SMSF, not the Holding Trust. Therefore, the income received from the Holding Trust (for example, rent received from a tenant) is a gross income amount, regardless of the interest expenses — which are met by the SMSF not the Holding Trust.
No. The Decisions are edited and summarised records of ATO decisions only and do not have the force of law.
However, if a taxpayer does not follow an interpretative decision and the decision ultimately proves to be correct, then this could have implications for culpability penalties.
You can access each of the Rulings at:
For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Commercial team.
You can read earlier ClearLaw articles on a wide range of SMSF topics.
Allen v Federal Commissioner of Taxation(2011) 195 FCR 416.
Andrew is a lawyer in the Maddocks Tax & Revenue team.
Andrew provides advice on:
His advice covers both direct and indirect tax considerations.
Prior to joining Maddocks, Andrew was a tax consultant at a Big 4 Chartered Accounting Firm.
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For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of their team.