PRACTICAL COMPLIANCE GUIDELINES
The Practical Compliance Guideline (PCD 2016/5) was issued by the ATO on 6 April 2016 to provide guidance on what constitutes commercial terms in relation to limited recourse borrowing loan agreements (LRBA). We encourage all of our clients to read this guide.
Who is affected by this PCG?
Are you a Self-Managed Superannuation Fund (SMSF) trustee?
Have you established Limited Recourse Borrowing Arrangements?
Have you acquired assets under an LRBA?
Does that asset generate income?
If you answered yes to all of the above questions, then this Guideline affects you.
Non-arm's length income
The ATO takes the view that non-arm's length income (NALI) provisions in s 295-550 of the ITAA 1997 can apply when an SMSF trustee undertakes LBRAs that are established or maintained on terms that are not consistent with an arm's length dealing.
In order to avoid having to report NALI for the 2015/16 year (and prior years) the SMSF has a number of options:
- Structure the terms of the LRBA in accordance with the Safe Harbour terms as set out below
- Refinance the loan to a commercial lender
- Pay out the LRBA (if the LRBA was established before 30 June 2016)
- Maintain evidence that shows the particular arrangement is established and maintained on terms that replicate terms of a commercial loan that is available in the same circumstances
The effect of this guideline
Acquiring real property under an LRBA
The ATO accepts that an LRBA used to acquire real property (residential or commercial premises), or to refinance a borrowing used to acquire real property is consistent with an arm's length dealing if the terms of the borrowing under the LRBA are established and maintained in accordance with the terms in the table below under "Safe Harbour 1"
Acquiring stock exchange listed shares under an LRBA
The ATO accepts that an LRBA used to acquire or to refinance a borrowing used to acquire stock exchange listed shares or stock exchange listed units in a unit trust is consistent with an arm's length dealing if the terms of the borrowing under the LRBA are established and maintained in accordance with the terms in the table below under "Safe Harbour 2"
Terms consistent with an arm's length dealing
| Item | Safe Harbour 1 | Safe Harbour 2 |
| Interest rate |
For the 2015-16 year, the rate is 5.75% For the 2016 17 and later years, the rate published for May |
For the 2015-16 year, the interest rate is 5.75% + 2% = 7.75% For the 2016-17 and later years, the rate published for May plus 2% |
| Fixed/variable |
Interest rate may be variable or fixed If variable, use 5.75% If fixed, trustees may choose the rate at the commencement of the arrangement for a period of up to a maximum of 5 years |
Interest rate may be variable or fixed If variable, use 7.75% If fixed, trustees may choose to fix the rate at the commencement of the arrangement for a specified period, up to a maximum of 3 years |
| Term of the loan |
Variable interest rate loan (original) - 15 year maximum loan term (for both residential and commercial) |
Variable interest rate loan (original) - 7 year maximum loan term (calculated from start date of original loan) |
| Loan to Market Value Ratio (LVR) |
Maximum 70% LVR for both commercial and residential property e.g. asset purchased for $500k is valued at $643k at 1 July 2015. The maximum LVR is $450,100. Therefore if $500k was borrowed to purchase the asset, the trustee must make a principal payment of $49,900. The market value of the asset established when the loan (original or re-financing) is entered into. But if the LRBA is already in place, then the market value as at 1 July 2015 can be used. |
Maximum 50% LVR The market value of the collection of assets is to be established when the loan (original or re-financing) is entered into. |
| Security |
A registered mortgage over the property is required |
A registered charge/ mortgage or similar security (that provides security for loans such as assets) |
| Personal guarantee |
Not required |
Not required |
| Nature and frequency of payments |
Each repayment is of both principal and interest Repayments are monthly |
Each repayment is of both principal and interest Repayments are monthly |
| Loan agreement |
A written and executed loan agreement is required |
A written and executed loan agreement is required |
Consequence of not complying
Income generated by the asset that is deemed to be NALI is taxed at 45%.
SMSF's with LRBAs established before 30 June 2016:
The ATO will not select an SMSF for an income tax review for the 2014-15 year or earlier years purely because the SMSF has entered into an LRBA. SMSF trustees have an opportunity to review the terms of their funds' LRBAs before 30 June 2016. The terms of their LRBAs will not be subject to any further compliance action for the 2014-15 income years (or before) if, by the 30 June 2016:
(i) the LRBA terms are amended to be consistent with an arm's length dealing,
OR
(ii) the LRBA is brought to an end, and the payments of principal and interest are made under LRBA terms consistent with an arm's length dealing.
What to do now:
If you ordered a LRBA loan agreement from our website recently then it will require an update. We have prepared an amending deed to print the terms of your LRBA loan agreement in line with the recent ATO guidelines. To order the amending deed just click here: http://www.legaledocs.com.au/page/lrba-loan-agreement/47