SMSFs unable to access the required loan amount through a commercial limited recourse borrowing arrangement (LRBA) should be cautious when using a second related-party arrangement that it does not breach loan rules or the non-arm’s-length income (NALI) provisions, according to an SMSF technical expert.
Heffron SMSF technical and education services director Leigh Mansell recognised cases of an SMSF using two LRBAs are less common since the ATO released guidance on the operation of the NALI provisions, but it was possible to use two loans to acquire an asset such as property.
“There’s nothing in the Superannuation Industry Supervision (SIS) Act or Regulations that says you can’t have more than one loan to acquire a property,” Mansell said during a recent online briefing.
“The critical thing is that SMSFs are prohibited from borrowing except for certain circumstances and one of those circumstances is when borrowed funds are used to acquire an asset. If you use two loans to acquire an asset, make sure the documentation for both loans points to the acquisition of that particular asset.”
She noted that while the SIS Act and Regulations may allow two loans, SMSFs also had to deal with taxation law and in particular the need for related-party dealings regarding the fund to be at arm’s length.
“Tax law creates a situation where both loans need to comply with an arm’s-length arrangement. The ATO in its practical compliance guideline for NALI states a related-party loan must be benchmarked to an offer made to the fund trustee to buy that particular asset,” she explained.
“The hiccup you get with two loans to buy one asset is people use the safe-harbour terms and conditions for the second loan, which state there’s a maximum 70 per cent loan-to-market value ratio (LVR) at the time you enter into the borrowing.
“If you’ve got a bank lending 60 per cent, the only extra bit that could be the related-party loan is to top up to 70 per cent, so it wouldn’t work if you were trying to use the safe-harbour rules.”
Mansell added commercial lenders may also block a second loan as they would want to be considered as the holder of the first mortgage with veto rights on other lending arrangements.
“If you’re using a commercial lender, they will want the first mortgage and to comply with the safe-harbour terms on the other loan it would be a second mortgage over the property, but the loan contract with the commercial lender might say you’re not allowed to borrow against this property without its permission,” she said.
“So, you might be hamstrung in being able to get a second loan to fund the purchase even if you do meet the 70 per cent LVR.
“With SIS you might be okay, but the problems are going to be with tax law and complying with an arm’s-length arrangement and not ending up with non-arm’s-length expenses, which will end with a capital gain and rental income on that property taxed at 45 per cent when it is sold.”