ATO to Get Tougher on Related Party Loans to SMSF’s

Ron Doig|21st January 2016

In late 2015, the ATO announced that it expected to see all related party loans to SMSF’s to be on arm’s length terms.

Expected compliance is by 30 June 2016.

This is a very significant reversal of previous ATO views, and the steps to take are far tougher than merely ensuring the interest rate is commercial.

Recent statements indicated that not only must the interest rate be at commercial arm’s length terms, but other arrangements must also be consistent with what is in the market place, for example:

  • security such as a registered mortgage;
  • loan ratios and arrangements regarding capital repayment.

The ATO issued two Interpretative Decisions which suggest that the Commissioner will assess the circumstances “holistically” to determine whether the arrangements are on arm’s length terms.

This is based on the decisions of:

  • Allen v FCT which suggests the totality of the steps taken by the parties should be considered; and
  • FCT v AXA which adopted the view that the parties must deal with each other “so that the outcome of their dealing is a matter of real bargaining”, or such that “the inference they are not dealing at arm’s length has been displaced.”

Relevant factors to be considered include:

  • the interest rate charged by the lender;
  • the repayment terms;
  • the security;
  • the loan to value ratio; and
  • whether or not personal guarantees are given.

A recent but little known AAT decision (Ali v FCT) not mentioned by the ATO made a brief comment in relation to the arm’s length requirement in the superannuation legislation.

The comment is consistent with the ATO approach for tax that, for an arrangement to be at arm’s length, it must be something that is offered by commercial providers in the market place.

Banks offer limited periods where interest rates are fixed and limited periods for which loans are interest only.

Banks typically require personal guarantees.

If a loan is not guaranteed by the fund members, thought should be given:

  • to whether or not it should be, and
  • if so whether there needs to be an arrangement with the fund to limit the guarantor’s rights of recovery against the fund to the asset purchased.

If needed, loan agreements should be amended, and mortgages prepared and lodged.

Mortgages may not be registerable, e.g. if the custodian and the lender are the same parties. Such arrangements will need review, but should be consistent with the original “instalment warrant” model where the lender is the registered owner of the asset.

Tasks

Any related party loan to a superannuation fund must be checked to see that all aspects are consistent with bank or third party financier offerings.

Everything should be properly documented.

All of this should be in place and complete by 30 June this year.

Tax Penalty

The ATO view is that a loan not meeting the requirements results in all of the ordinary and statutory income from the asset being subject to the penalty “non-arm’s length income” rate of 47%.

If you require assistance, or if you have any superannuation query, please contact Ron Doig by email or call 08 9426 6222.