On 28 September 2016, the ATO released a Practical Compliance Guideline PCG 2016/5 and a Taxation Determination TD 2016/16, in relation to limited recourse borrowing arrangements and 'arm's length terms'.
The ATO has revised its previous position and clarified the circumstances, and the extent to which, a SMSF may be exposed to non-arm's length income tax assessments when they enter into these borrowing arrangements.
The ATO's revised approach represents a more balanced approach regarding these issues.Stephanie McLennan, Maddocks Lawyers
The release of the Practical Compliance Guideline (PCG 2016/5) and the Taxation Determination (TD 2016/16) have altered the way the ATO will treat limited recourse borrowing arrangements (LRBAs) with related party lenders, for the purposes of determining exposure to the non-arm's length income (NALI) provisions in section 295-550 of ITAA 1997 (Act).
The ATO will only treat dealings as being on arm's length terms if the arrangements reflect what might be expected to have occurred if the parties to the scheme had been dealing with each other at arm's length. For example:
When assessing whether an arrangement is on arm's length terms, the ATO will assess whether the SMSF has derived more ordinary and statutory income under the scheme then it might have been expected to derive if the parties had been dealing with each other at arm's length in relation to the scheme.
In order to determine what the parties might have been expected to derive had the parties been dealing with each other at arm's length (hypothetical situation), one must identify:
Once the hypothetical situation has been determined, it is necessary to consider whether the SMSF would have or could have entered in to the hypothetical borrowing arrangement. This is a very important assessment and bears out the key difference from the ATO's previous position (as explained further below):
Factors the ATO considers concerning whether the SMSF 'could have' include:
Factors the ATO considers concerning whether the SMSF 'would have' include:
We described in our earlier article the ATO's previous position and explained our alternative view: we note that the ATO's new position corresponds with our alternative view.
The ATO's previous position can be summarised as follows:
It might be expected that an arm's length lender would not lend any capital on the loan terms that form part of the scheme. Without that loan it might be expected that there would be no investment in the asset through the Holding Trust and so no ordinary or statutory income might be expected to be derived by the Fund from the asset.
It is no answer to this conclusion to say that the Fund could have obtained a loan from an arm's length lender on different terms or that the Fund could have used other means by which to acquire the asset, as that is not the scheme into which the parties have entered.
For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Commercial team.
 ATO ID 2015/28
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.