Updated guidance released by the ATO in regards to its treatment of non-arm’s-length expenditure (NALE) has re-emphasised that a limited recourse borrowing arrangement (LRBA) that has breached those provisions cannot be made compliant with retrospective changes.
DBA Lawyers lawyer Fraser Stead highlighted the revised draft Law Companion Ruling (LCR) 2021/2DC, released for comment on 27 November, maintained its stance that once an LRBA had breached the rules, the tax consequences could not be undone.
“The ruling gives us guidance that you have NALE if there is a sufficient nexus between the expenditure and gaining or producing relevant income and you have specific NALE if that nexus is between gaining or producing income for a particular asset,” Stead said during an online briefing late last week.
“An example of this might be expenditure incurred in acquiring an asset, and paragraph 18 of the LCR states NALE incurred to acquire an asset is a specific expenditure and will have a sufficient nexus to all of the ordinary or statutory income derived by the fund.”
He said it was important for SMSF trustees to remember NALE would impact both forms of income tied to the asset, which would include any capital gain on disposal and rent derived from a commercial property, but also extended to any means of acquisition that occurred on a non-arm’s-length basis.
“We have the same commentary [regarding NALE and income] regarding refinancing a non-arm’s-length LRBA to an arm’s-length LRBA. This would still be NALE for capital gains tax purposes,” he added.
“So it is still important when setting up an LRBA that you have those terms in accordance with the safe harbour provisions or they represent commercial arm’s-length dealings.
“When you enter into an LRBA and its terms are not commercial and at arm’s-length, you cannot refinance in a later year and switch up the interest rate so that it is representative of a commercial rate or change the term or change the repayment period. That’s still going to be specific NALE and it’s still going to taint that asset.”
