SMSFs using a Division 7A loan from a related entity to fund a limited recourse borrowing arrangement (LRBA) can ensure the arrangement meets the dual lending criteria of the tax and superannuation rules by following the established practical compliance guidelines (PCG) safe harbor rules, according to a specialist educator.
Smarter SMSF chief executive Aaron Dunn advised an LRBA funded via a Division 7A loan must meet lending criteria set out within the Income Tax Assessment Act (ITAA) 1936 and safe harbour conditions within PCG 2016/5 and that the latter has a higher standard meaning adherence with it will ensure the same to the former.
Speaking during an online briefing today, Dunn noted Division 7A and PCG 2016/5 both have criteria in regards to the interest rate related to the loan, the length of its term and the loan to value ratio (LVR) and while the criteria in PCG 2016/5 was more restrictive it would ensure a Division 7A funded LRBA remained compliant.
“A Division 7A loan must have a minimum interest rate and the benchmark interest rate for this year is 4.77 per cent,” Dunn said.
“In the [PCG] safe harbour guidelines, we have a rate that is published each year, based upon the Reserve Bank rate as indicated in May each year and we have 5.35 per cent, as the rate that is being applied for the 2022/23 year.
“Division 7A requires the interest rate on the loan to be at least the benchmark interest rate, which is currently 4.77 per cent, so we actually tick both boxes by using the 5.35 per cent [rate].”
Looking at loan terms, Dunn confirmed the safe harbour rules limit an LRBA to a maximum of 15 years, compared to 25 years under a Division 7A loan, but that this limit has other compliance benefits.
“If we are complying with the LRBA safe harbour we are restricted to a maximum of 15 years because if we take ourselves up to the 25 year limit, then we are exposing the fund to the NALI rules unless we can evidence that it is an arms-length dealing.
Dunn added the tighter terms of PCG 2016/5 also extended to the LVR which was 70 per cent compared to up to 110 per cent under the Division 7A rules.
“With the SMSF we will have that LVR but also require a mortgage, which is the same size as a 25 year loan for Division 7A, and make principal and interest repayments monthly as well as having a written and executed loan agreement.
“Generally speaking, if we stay within the construct of the safe harbour terms [in PCG 2016/5] and have an entity that is acting as the related party borrower, we should be ticking off those requirements within Division 7A well but a belt and braces approach would still work through each item each year.”
