The ATO’s decision not to take compliance action regarding non-arm’s-length income (NALI) for a further 12 months should not mean SMSF limited recourse borrowing arrangements (LRBA) with a related-party lender (RPL) can operate outside current safe harbour guidelines.
DBA Lawyers director Dan Butler said the ATO had outlined the safe harbour provisions under which an SMSF can use an LRBA with an RPL in Practical Compliance Guideline (PCG) 2016/5 and those remain in force despite the ATO taking a ‘no-action’ position on NALI until after the 2021 financial year.
Butler pointed out that in April the ATO stated the NALI provisions would not apply to repayment relief from the related party to the SMSF trustees if the relief was on similar terms to that offered by commercial banks, was documented and the interest continued to accrue on the loan, and outstanding interest and principal payments were made as soon as possible.
Referencing the NALI provisions in the Income Tax Assessment Act, he said during a recent webinar: “If an SMSF incurs a loss, outgoing or expenditure less than if those parties had been dealing with each other at arm’s length, that is non‐arm’s-length income.”
He said this position had been restated in PCG 2020/5 issued by the ATO on 1 June where the regulator indicated it would not take action regarding non‐arm’s-length expenditure (NALE) of a general nature that had a nexus to ordinary and/or statutory income derived by the fund.
This position, however, would not apply where the fund incurred NALE directly related to the fund deriving particular ordinary or statutory income.
“Putting COVID relief in respect to LRBAs aside, in a normal situation if an SMSF got a lower interest rate than one received at arm’s length that would be directly related to the borrowing of the particular property and therefore would be expenditure directly related to that particular income, and would not be saved under this PCG,” Butler said.
He also highlighted that the explanatory memorandum for the Treasury Laws Amendment (2018 Superannuation Measures No 1) Bill 2019, which contains the NALI provisions, states that a “non‐arm’s-length interest on borrowings to acquire an asset will result in any eventual capital gain on disposal of the rental property being treated as non‐arm’s-length income”.
“For the time being, try really hard to stay within PCG 2016/5, that is, can your clients continue regular monthly principal and interest payments?” he said.
“If they need to, they can rely on the non-binding comments from the ATO regarding related-party LRBA relief, but at the end of this COVID-19 period, in September 2020, they will be expected to start regular monthly repayments unless a further extension is granted.”