The ATO has issued a reminder to SMSF advisers and trustees about how the non-arm’s-length income (NALI) provisions apply to limited recourse borrowing arrangements (LRBA) in light of the looming compliance deadline for these gearing strategies.
During 2016, the tax office published Practical Compliance Guideline PCG 2016/5, which stipulated the safe harbour conditions that if complied with would guarantee any income derived by an SMSF from an LRBA would automatically be treated as the result of a commercial arm’s-length transaction.
Subsequent to PCG 2016/5, the ATO also issued Taxation Determination TD 2016/16, specifying the circumstances whereby an SMSF’s income from an asset held under an LRBA would be considered non-arm’s length in nature and taxed accordingly.
The latest correspondence from the regulator reinforces how these two publications are intended to operate in conjunction with one another.
Firstly, the ATO specifies SMSF trustees and their advisers need to determine if the LRBA in place adheres to the conditions specified in PCG 2016/5. It goes on to say if it does not, the trustees then need to demonstrate the LRBA has still been established on an arm’s-length basis.
“If the answer is yes, then trustees do not have to consider TD 2016/16 and are assured that we will not seek to apply the NALI provisions on the basis of the borrowing terms under the arrangement,” it said.
“TD 2016/16 only needs to be considered if an SMSF has an LRBA on terms that are non-arm’slength.
“This is because in these circumstances, trustees need to consider the second limb of the NALI provisions and whether or not the income the fund obtains under the arrangement is greater than it would otherwise have been.”
The ATO specifically pointed out TD 2016/16 was not an alternative to the safe harbour conditions defined in PCG 2016/5.
It also reminded SMSF trustees and advisers all LRBAs had to comply with the arm’s-length terms by 31 January or be terminated if that was not possible.
