Flawed LRBAs will create unfixable NALE taint


LRBAs started in non-arm’s-length circumstances will trigger NALE unless they are ended and restarted on new terms that comply with new ATO requirements.

Limited recourse borrowing arrangements (LRBA) that were started under non-arm’s-length circumstances will create a non-arm’s-length expenditure (NALE) issue that can never be rectified and will be linked to all income generated by the fund, an SMSF legal expert has warned.

DBA Lawyers director Dan Butler pointed out the finalised Law Companion Ruling (LCR) 2021/2 released recently by the ATO made a distinction between non-arm’s- length arrangements that were one-off and those that were recurrent.

Butler said the regulator had changed its view during the consultation for the LCR that every general expense could blow up a fund and shifted it to a general expense that was unrelated to the acquisition of an asset would only impact certain financial years, but some LRBA arrangements would be trapped under this definition.

“If NALE is incurred to acquire an asset, all future income – ordinary and statutory – including the capital gain, will be considered NALE,” he said during a recent webinar.

“However, if it’s not related to an acquisition and it’s NALE, such as a lower accounting cost in one year, then it only taints the income in that particular financial year, so it only taints a financial year if it is NALE of a recurrent nature.

“The classic expense of a recurrent nature is interest on a LRBA and if you have started an LRBA on the wrong footing, you can never fix it, and all the income and capital gain will be tainted as NALE.

“We have clients already looking at disposing of assets and volunteering a disposal in their tax return as NALE, so they can start off on a clean slate.

“There is a need to get the issue of recurrent expense right because the ATO states where you have started on the wrong foot, there is no way to get back on the right foot.

“There is no way, at law, they can fix it. Even if you subsequently go to all the trouble of putting that LRBA back on the right foot. Bad luck, it’s a fail.”

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