NALI compels LRBA conservatism


SMSF advisers have been warned not to take an aggressive stance with LRBA interest rates involving related parties to avoid invoking the NALI rules.

An SMSF consultant has recommended advisers and their clients adopt a conservative approach when faced with a choice as to the interest charged on limited recourse borrowing arrangements (LRBA) when a related party is involved to ensure the non-arm’s-length income (NALI) provisions are not triggered.

BDO Adelaide senior consultant Peter Crump made the suggestion with regard to situations where two sets of benchmark interest rates conflict with one another. This set of circumstances currently exists for trustees who are unsure as to whether to use the interest rates outlined in Division 7A of the Income Tax Assessment Act (ITAA) or the interest rate stipulated in ATO Practical Compliance Guideline (PCG) 2016/5.

Specifically, under Division 7A of the ITAA an interest rate of 4.77 per cent should be charged for any loan made by a private company to an associated party in the 2023 income year.

In contrast, PCG 2016/5 dictates an interest rate of 5.35 per cent must be levied for an LRBA involving a related party where the asset involved is real property and similarly decrees an interest rate of 7.35 per cent for investments in listed shares or units under the NALI safe harbour rules.

“The safest thing to do is apply the greater of the two rates regardless of which is higher. The fact that the rates are likely to be extremely close together does give some comfort,” Crump told attendees at the SMSF Association Technical Summit 2022 on the Gold Coast last week.

“If there was a substantial divergence with the rates, then you may have a problem with the safe harbour provisions pushing you too high [with regard to the interest charged] relative to Division 7A, but the fact that they are close together means you would always take the greater of the two.”

He added if the SMSF trustees note they are following this dual guidance in making the decision on the interest rate charged, then no NALI issues should arise.

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