Limited Recourse Loans from related parties : ATO guidance PCG 2016/5
Important ATO Guidance regarding LRBAs from related parties: Action required before 30 June 2016
The ATO today (6 April 2016) issued a Practical Compliance Guideline (ATO PCG2016-005 LRBA Non Arms Length arrangements) in relation to Limited Recourse Loans provided by related parties to the members of the Self-Managed Superannuation Fund (“SMSF”).
The ATO has been progressively modifying their approach to such loans in recent years (even at one point issuing releases that 0% interest rate on such loans was acceptable). Over the past couple of years the general advice was to ensure such loans “were commercial and arm’s length”.
The Guidelines released today clarify what the ATO would regard as “commercial” and therefore excluded from the application of Non-Arm’s Length Income (“NALI”) rules (Income classified as NALI is taxed at the top marginal personal tax rate). Please note this guidance only applies to LRBA where a related party has provided the funds. Where an independent financial institution (i.e. major bank) has provided the loan, these guidelines will not apply.
In order to satisfy the ATO’s guidance any LRBAs from related parties used to fund property purchases need to be structured as follows:
|Item||ATO Guideline||Potential actions required by 30 June 2016|
|Interest rate||RBA indicator rate for banks providing standard variable housing loans to investors (5.75% for the 2015/16 year)
|Adjust interest payment for 2015/16 year
Update loan agreement to apply ATO wording as to interest rate applicable
|Term of loan||Maximum 15 years for original loan||Update loan agreement to reflect maximum 15 year term
Recalculate payments consistent with maximum 15 year term. This may involve a catch up payment to bring loan into line with maximum 15 year term. This will need to be completed prior to 30 June 2016
|Maximum loan to value ratio||70%||May require additional principle repayment to bring loan into line with maximum 70% value ratio. This will need to be done prior to 30 June 2016|
|Security||Registered Mortgage required||Mortgage will need to be registered prior to 30 June 2016 if not currently in place|
|Personal Guarantee||Not required|
|Nature and frequency of payments||Monthly repayments on principal and interest basis||Catch up payments consistent with maximum 15 year principal and interest loan if necessary|
|Loan Agreement||Written and executed||Any changes noted above will need to be reflected in updated and executed Loan agreement (i.e. if you need to make changes you will also need an updated loan agreement)|
Please note: there is separate guidance for LRBAs used to fund share purchases but in our experience these are very rare. A PDF of the full set of Guidelines is attached
Importantly, any related party LRBAs are required to be compliant by 30 June 2016. As noted above, in some cases this will involve significant action by Trustees and their advisors (i.e. their accountants).
Changes to loan agreements need to be carefully considered as it is likely this can only be done in a manner that legally extinguishes terms that currently apply and replacing them with revised enforceable terms. The terms of many agreements will not provide for changing interest rates and repayments – in such cases a new borrowing agreement will need to be drawn up and executed. This will almost certainly require involvement of appropriately qualified legal experts.
I expect there will be significant coverage of this matter over the next few weeks. In the interim, given that 30 June 2016 is only 12 weeks away, I would recommend you urgently review your fund it has a related party LRBA and consider if any action needs to be taken in order to comply with these changes.