The ATO will provide administrative relief for limited recourse borrowing arrangements (LRBA) involving a Division 7A loan where the fund using the borrowing instrument has received temporary repayment relief due to COVID-19.
The regulator announced the measure via an LRBA repayment relief update on its website, noting trustees and advisers should read the guidance if an SMSF has an LRBA from a related private company where Division 7A of the Income Tax Assessment Act 1936 (ITAA) applies and the fund has negotiated repayment relief with the lender on commercial terms as a result of the financial impacts of the coronavirus.
“The new guidance is here to help SMSF trustees determine how to avoid the application of non-arm’s-length income (NALI) rules, especially if unpaid interest has not been capitalised on the loan during the payment deferral period,” it stated.
Specifically, it noted: “Where temporary repayment relief has been given with respect to an LRBA between an SMSF and a lender, and that loan is also a Division 7A loan, there will be no Division 7A consequences as a result of the interest being capitalised on the loan.”
The guidance added capitalised interest will not count in determining if the minimum yearly loan repayment had been met for Division 7A purposes and explained to avoid the unpaid amounts being taxed as unfranked dividends, SMSFs can apply for Division 7A administrative relief if they were unable to make the minimum yearly repayment by the due date under the ITAA rules.
The ATO also provided guidance on how the interaction between uncapitalised interest and a Division 7A loan would operate with regards to the application of NALI, offering a no-compliance position but under a range of conditions.
“While there is nothing preventing the capitalisation of interest on Division 7A loans under the Division 7A administrative relief, we understand that there is a view that interest cannot be capitalised on such loans given their Division 7A nature,”it said.
“Therefore, for the 2019/2020 and 2020/2021 income years, where an LRBA between an SMSF and a lender is subject to repayment relief but unpaid interest on the loan is not capitalised, we will not take compliance action to determine if the NALI provisions apply.”
The ATO added this no-action position would only apply if the LRBA was also subject to a complying loan agreement, for Division 7A purposes, and the SMSF had either met its minimum yearly repayment or applied for Division 7A administrative relief where it was unable to do so, and the temporary repayment relief was due to the COVID-19 financial hardship and was offered on similar terms to those offered by commercial banks.
