The ATO has flagged the key risk factors it examines in regards to related-party funding arrangements, many of them common in SMSF borrowings, noting that where a number of factors are present, the likelihood the regulator will take compliance action increases.
In a recent update on its website, the regulator stated it was looking at funding structures, debt, interest payments, loan terms and repayments as they relate to private entities being involved in property and construction.
In regards to funding structures, it said arrangements where no or limited equity was contributed by the investor or developer and funding that appeared to be equity under arm’s-length conditions but was treated as debt would attract its attention as “this is a risk because insufficient equity or excessive debt may result in excessive interest deductions”.
On the topic of debt, it stated insufficient evidence to support the arm’s-length nature of related-party loans and interest expenses on related-party loans that would cause an investment or development to have questionable viability were of concern, as was any related-party debt that exceeds what was expected between parties acting at arm’s length in comparable circumstances.
“This is a risk because a non-arm’s-length amount of related-party debt may result in excessive interest deductions,” it noted.
The deferral of a payment of interest when a borrower had financial capacity to meet payment obligations on related-party loans was also raised as an issue as there was a risk this action may result in the avoidance of interest withholding tax and the denial of interest deductions.
The terms of arrangements are also likely to come under scrutiny where the ATO identifies a misalignment between the funding needs of an investment or development and the term of the related-party loan. It would also examine the existence of unpaid principal and accrual of interest on related-party loans beyond the investment period, project completion or term of the related-party loan.
It would also examine repayments, including where related-party loans for property investments were not repaid after a property was sold and the movement of funds from a completed project to another project without repaying the loan.
“Where one or more of these factors are present, the risk of your related-party funding arrangement increases and you are more likely to attract compliance activity,” it said.
“We expect you to carefully consider the commerciality of your arrangement and maintain documentation and evidence to support your approach.”
