SMSFs using limited recourse borrowing arrangements (LRBA) need to ensure loan repayments are based on an appropriate interest rate to prevent any income being taxed under the non-arm’s-length income (NALI) rules.
Addressing attendees at the Institute of Public Accountants National Congress in Adelaide last week, SuperConcepts SMSF technical services executive manager Mark Ellem said SMSFs using a related-party loan inside a LRBA should use the safe harbour rates if they were unable to secure the loan at commercial rates.
“Related-party loans are becoming more common because there are less institutions offering loans and if an SMSF is not using the safe harbour rates, then the fund has to prove the related-party loan is on commercial terms,” Ellem said.
“This can’t be done by going to a bank website and seeing that it can do this type of loan at a certain rate and stating that is the rate the LRBA will be using.
“In our view, to use the commercial rates comparative approach a fund would have to apply for the loan, get the letter of offer and then reject it because how would it know the bank would give those terms unless they were offered.”
He added any reliance on published rates from banks was also likely to be wrong as the types of loans on offer differ from those used in LRBAs.
“The banks may be charging lower rates, but the question is on what type of loans? This is a trap SMSF clients fall into when they see home loans at lower rates which are offered over 30 years compared with a maximum of 15 years for an LRBA, and are also full recourse instead of non-recourse,” he said.
He pointed out SMSFs that were unable to secure commercial rates only had the option of using the safe harbour rates, despite the fact they had increased while the Reserve Bank of Australia had continued to decrease official interest rates.
“In May of this year, the benchmark safe harbour rate went from 5.8 per cent to 5.94 per cent as it is based on the investor home loan rate, and in May the rates were high and the outlook was good,” he said.
“As a result of this, if an SMSF has a LRBA with a related-party loan and is using the safe harbour rates, the interest rates and the monthly payments would have to be adjusted to cater for the increase to 5.94 per cent.
“If they are not adjusted, then the fund is not in compliance with the safe harbour rules and will have to prove the loan is on commercial terms or be at risk of net income from that arrangement being treated as NALI and taxed at 45 per cent.”
Earlier this year, Townsends Business & Corporate Lawyers cautioned that SMSFs with a LRBA from a related party should follow the safe harbour guidelines to prevent the loan being considered as a dividend and also subject to Division 7A of the Income Tax Assessment Act (ITAA).
