Non-use of safe harbour triggers breach

Red flag on beach.

SMSFs not using safe harbour terms may be questioned by auditors.

SMSF trustees opting not to follow the safe harbour guidelines for related-party loans must be ready to demonstrate the loan was entered into and maintained on terms consistent with an arm’s-length dealing, an industry lawyer has warned.

An auditor recently considered non-adoption to be a breach of the Superannuation Industry (Supervision) (SIS) Act, Townsends Business and Corporate Lawyers solicitor Julie Hartley revealed.

Hartley said the ATO’s “Practical Compliance Guidelines 2016/5” provides safe harbour terms, which, if complied with, mean the related-party loan will be treated as commercial by the tax office and accordingly the trustees can be assured non-arm’s-length provisions of the Income Assessment Act will not be applied to the arrangement.

In addition, in April 2016 the ATO assistant commissioner stressed the adoption of the safe harbour terms was not compulsory and simply a safety net for trustees.

“As far as we are aware, the ATO’s position on this issue remains unchanged,” Hartley said.

“Surprisingly, we have recently been made aware by one of our clients that an auditor listed the failure to follow the guidelines as a breach of section 109 of the SIS Act in their contravention report.”

She said in this situation, the auditor should firstly notify the trustee as soon as a contravention is detected to allow the SMSF trustee to respond to the issue and, if possible, rectify or have a plan in place to rectify before the audit is finalised.

Secondly, the trustee may decide to wait and see what action the ATO takes, if any.

However, to avoid this issue in the first place, Hartley recommended trustees follow the guidelines from the start of the arrangement.

“They may obtain a loan offer to the SMSF from a bank or other commercial lender in relation to the particular asset and benchmark the terms of the related-party loan to the loan offer,” she said.

“The loan offer should be safely kept on the fund register so it can be readily produced to the ATO or auditor as evidence if requested.

“If a trustee is thinking of entering into a related-party loan and is still unsure whether the proposed terms would be commercial, they may apply for a private binding ruling to the ATO.”

She warned a private binding ruling is an advice from the ATO that outlines how a tax law – in this case, the non-arm’s-length income rules – applies to an SMSF in its particular circumstances and once issued the ruling is binding on the ATO.

“The downside of this is if the trustee chooses not to rely on the private binding ruling and ends up breaching the rules, they will be required to pay any underpaid tax, and interest, as well as a penalty,” she said.

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