The Australian Taxation Office (ATO) has announced its intention to make zero interest related-party loans to SMSFs unattractive by defining the income derived from the assets acquired through these loans as non-arm’s-length, which will result in a substantial tax liability.
The ATO’s new approach was recently evidenced via Private Binding Ruling 1012396819768, which involved a new interpretation of section 295 to 550(5) of the Income Tax Assessment Act (ITAA).
The subsection of the ITAA applies if income derived by an SMSF is greater than would have been expected had a non-arm’s-length transaction not taken place.
The private binding ruling saw the ATO argue section 295 to 550(5) of the ITAA applied to zero interest related-party loans on two fronts.
The first being had the zero interest related-party loan not been in place, the fund would not have been able to acquire the income-producing asset. Subsequently the entire income derived from the asset acquired through the loan will be considered non-arm’s-length as the fund would have been earning zero income otherwise.
The ATO’s second argument is because these loans contain no interest component, the principal amount borrowed will be higher than would otherwise be available from a loan arranged under strict commercial terms, perhaps even 100 per cent of the asset’s value.
“Therefore, the substantially lower borrowed amounts available to be invested might expect to generate less income to be derived by the fund through the custody trust than under the proposed arrangement,” the ruling stated.
Wilkinson Super founder Mark Wilkinson said the ATO’s new interpretation was contentious.
“I do not agree with the ATO conclusion on this matter and do not believe that section 295-550(5) applies in the way in which is outlined,” Wilkinson said.
“It is therefore with interest that I can report that a private ruling that purported to come to a similar conclusion with regard to the application of section 295-550 is now the subject of an appeal.”
He said the ruling emphasised the need for trustees to reconsider and review those types of loans as well as the importance of receiving expert financial advice regarding those arrangements.
“However, regardless of whether the ATO is right or wrong on this matter, what is clear is that if your clients are thinking of using related-party loans in this manner, they should consider seeking specialist advice, applying for a private binding ruling or both,” he said.