Total LRBA contract needs checking

LRBA contract

SMSFs seeking evidence a related-party LRBA interest rate is on commercial terms should also check the entire borrowing contract falls under the same standard.

SMSF members seeking evidence a related-party limited recourse borrowing arrangement (LRBA) has been made on commercial terms should examine if the entire contract arrangement, and not just the rate, fits that criteria, an SMSF administrator has recommended.

Heffron client relationship manager Sean Johnston said SMSFs were most likely seeking evidence an LRBA was on commercial, arm’s-length terms when it could not use the safe harbour rules nor find a lender to provide a benchmark as the loan was to be used to purchase units in an unlisted property trust.

“Before we go down the path of proving that the interest rate of the LRBA is commercial, we have to take a step back and consider if the whole arrangement needs to be commercial, not just the interest rate,” Johnston said during a webinar today.

“If I can’t go out to a third-party lender and get a loan for this because the security is not good enough, or for any other reason for that matter, then the whole arrangement falls over because by definition it is not arm’s length.

Quite often we jump onto the interest rate but don’t consider all the terms and conditions of the arrangement. We seem to get hung up on the rate and what we should be doing is going have a look at the agreement in its totality.”

Heffron SMSF technical and education services director Leigh Mansell added consideration relating to security over the loan, penalty clauses and repayment schedules also needed to be included on the same basis as a commercial, third-party loan.

When you go to the bank and get a loan, you get a contract with all these terms and conditions and they are the things you are trying to replicate, not just the interest rate,” Mansell said.

“The safe harbor provisions [of ATO Practical Compliance Guideline 2016/5] would be a nice solution, but it doesn’t apply [to unlisted property trusts], but you could try to benchmark the loan to an offer made to the fund.

“We often tell clients to see if they can find a lender that is willing to lend to the fund via an LRBA with the securities limited to the asset in question, see what their terms and conditions are and replicate those terms, but that is often easier said than done.”

Johnston added: “If it turns out you cannot even find that, then it’s probably not an arm’s-length agreement.”

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