A specialist law firm has highlighted the need for money to physically change hands in a related-party loan arrangement in an SMSF to ensure the ATO recognises the borrowing aspect of the transaction.
“When it comes to related-party borrowing, the importance of actually transferring the loan amount from the lender to the borrower (or to the vendor at the direction of the borrower) is sometimes overlooked, particularly in the circumstances where the same individual is the vendor, the lender and the fund trustee (or director of the corporate trustee),” Townsends Business and Corporate Lawyers said.
The legal firm stressed having all of the correct transactional documentation proving the loan was executed on arm’s-length terms and the like may not be sufficient proof a borrowing arrangement exists in the eyes of the regulator.
“The ATO’s current view is that there needs to be a transfer of money from the lender to the borrower as a necessary feature of a borrowing as referred to in the Superannuation Industry (Supervision) (SIS) Act 1993,” Townsends said.
Further, the law firm warned the mere presence of bookkeeping entries could not be relied upon to signify the presence of a related-party loan and the ATO had been using some of its previous rulings to determine if there really is a loan in place or if the arrangement is considered a “financial accommodation”.
To illustrate the point, Townsends cited a scenario where a property held by the sole member of an SMSF who is also a director of the fund’s corporate trustee valued at $1 million was sold to the SMSF for a cash payment of $800,000 and a loan from the director of $200,000.
The firm pointed out in this situation the director would have to physically advance the $200,000 to the SMSF and receive the full consideration for the property of $1 million from the fund.
According to Townsends, trustees and their advisers needed to be aware of this approach from the ATO as related-party loans could be on the rise as a result of the withdrawal of lending from the major banks, and errors with these arrangements could have severe adverse consequences.
“If the transaction is deemed to be an arrangement other than a loan, the limited recourse borrowing arrangement exception under the SIS Act will not apply and this may expose the SMSF trustee(s) to civil and/or criminal penalties and place the SMSF’s complying status at risk,” it said.