The Australian Taxation Office (ATO) has issued two interpretive decisions reinforcing its stance on zero interest loans issued to SMSFs.
ID 2014/39 and ID 2014/40 both deal with situations where an SMSF acquired assets via a zero interest loan; the first being a limited recourse borrowing arrangement (LRBA) of several million dollars to purchase shares in several companies listed on the Australian Securities Exchange and the second being a $500,000 LRBA to obtain a real property.
In both cases the regulator ruled all of the income from the gearing strategies was non-arm’s-length and as such would be taxed at 47 per cent.
In making its rulings, the ATO concentrated on the loan-to-valuation ratio (LVR) of the two LRBAs, with ID 2014/39 dealing with a 100 per cent LVR and ID 2014/40 assessing a situation with an 80 per cent LVR.
Another area of ATO concern was that both LRBAs were long-term loans, with ID 2014/39 dealing with a 20-year repayment period and ID 2014/40 a 15-year repayment period.
Further, the regulator highlighted no personal guarantees were sought in either situation.
The entire set of circumstances led the ATO to conclude the income derived from each LRBA was higher than if the loans had been issued on an arm’s-length basis due to the zero interest aspect and the high LVRs.
Moreover, the ATO’s opinion was no income would have been generated had the two loans been at arm’s length, making the entire amounts of income from each LRBA subject to a 47 per cent tax rate.
After looking at the two decisions, SMSF specialist legal firm DBA Lawyers concluded: “Unless related-party LRBAs measure up to arm’s-length terms and conditions, the income derived by the SMSF is likely to be taxed as non-arm’s-length income unless the SMSF has obtained a prior favourable PBR (private binding ruling).
“Moving forward, SMSFs with related-party LRBAs should ensure they have benchmark evidence to support their arm’s-length terms and conditions.
“Those entering into such arrangements may seek to obtain a PBR.”
DBA Lawyers added it would be interesting to see how the ATO generally dealt with SMSFs with related-party LRBAs that did not measure up with arm’s-length terms and conditions and whether any action would be retrospective in nature.