The ability for an SMSF to implement a strategy of using a related party limited recourse borrowing arrangement (LRBA) to purchase certain assets not covered by the ATO safe harbour guidelines, such as a parcel of unlisted shares, without having the income from the investment being treated as non-arm’s length, may well be impossible.
The safe harbour conditions for related party LRBAs stipulated by the ATO in practical compliance guideline PCG 2016/5 only covered the purchase of listed shares and real property and acquiring assets falling outside of these categories via an LRBA that have onerous requirements to avoid associated income being classed as non-arm’s length and taxed at higher rates, according to Hall & Wilcox partner Heather Gray.
“In the PCG the ATO has said one example of how a trustee may demonstrate [an LRBA falling outside the safe harbour conditions] is by maintaining evidence that shows their particular arrangement is established and maintained on terms that replicate, and I emphasise the word replicate, the terms of a commercial loan that is available in the same circumstances,” Gray told Chartered Accountants Australia and New Zealand National SMSF Conference 2017 delegates in Sydney last week.
“So what they’re looking for there is something that is quite definitive. They’re not looking for something that is indicative, they’re looking for something that is definitive so how do you demonstrate that you’ve replicated the terms of a commercial loan.
“It’s a very onerous expectation in my view.”
Gray pointed out simply going to a bank website to print out the general terms and conditions and interest rates that were available at the time, including the applicable loan to value ratio, would not be enough for the ATO.
She suggested it might mean trustees had to actually apply for a loan to determine the specific commercial conditions.
“It’s a very difficult thing to expect people to be able to do and one thing to note there is what do you do if you’re looking to borrow to buy a parcel of unlisted shares or units and there is simply not something that’s available out in the market place for a loan such as that – you can’t find an external lender and you certainly can’t click around the internet and find indicative terms and conditions,” she explained.
“What the ATO says is where for example an LRBA is over an asset for which an SMSF could not find a commercial third party lender to provide finance to acquire that asset, and so entered into a related party loan, the trustee will be unable to demonstrate that the LRBA has been made on arm’s length terms.
“That’s pretty damning I think. What the ATO is saying there is if you’re not able to show that you could’ve gone to an external lender and got yourself a loan and be able to demonstrate what the terms and conditions of that loan were then, as far as demonstrating you’re acting on arm’s length terms, you’re really sunk.
“I think it’s a worry. They’re really saying it’s something you’re unable to do,” she concluded.