SMSFs accessing funding for a limited recourse borrowing arrangements (LRBA) from a related company or family trust have been warned they should follow the ATO’s safe harbour guidelines to prevent the loan being considered as a dividend and thus subject to Division 7A of the Income Tax Assessment Act (ITAA).
In a recent posting on its website, Townsends Business & Corporate Lawyers said recent inquiries had resulted in the firm revisiting the issue of what the status was of an LRBA sourced from a member’s family trust to their SMSF, and whether the arrangement is considered as a complying loan.
“Current safe harbour guidelines are more restrictive than the current Division 7A criteria (that is, higher interest rate, shorter maximum term, lower maximum LVR (loan-to-value ratio) and a mortgage has to be registered),” Townsends said, adding LRBAs from a related company or trust should also aim to meet the less restrictive criteria of Division 7A.
“An LRBA with a potential issue of Division 7A should meet both Division 7A criteria and the ATO’s LRBA safe harbour guidelines to ensure the loan is not deemed a payment of dividend under Division 7A and also is on arm’s-length terms as required under the SIS (Superannuation Industry (Supevision)) Act.”
The firm used an example of two SMSF members, with a corporate trustee, who had acquired commercial property in New South Wales under an LRBA through their fund to illustrate why both the safe harbour and Division 7A criteria should be met.
In the example, the property was financed by a private company of which the two members were also shareholders, leading to concerns the loan may not be a complying loan, but instead deemed as a payment of dividends from the company.
Townsends pointed out this type of loan would be exempted from being deemed to be a dividend under section 109N of the ITAA if it was made under a written agreement, had a minimum interest rate and a maximum loan term.
The loan would also meet the safe harbour guidelines dealing with loans on arm’s-length terms if it satisfied additional requirements, including a maximum loan term of 15 years, a maximum LVR of 70 per cent, monthly repayments of both principal and interest into a registered mortgage, which is used as security over the property, and the interest rate used is the Reserve Bank of Australia indicator lending rate for banks providing standard variable housing loan for investors.
The firm also highlighted any SMSFs with LRBA arrangements under the circumstances in the example that did not follow the safe harbour guidelines will still need to be able to demonstrate the loan is on arm’s-length terms and is benchmarked to a commercial LRBA.
