How low can your interest rate go? SMSF related party loans

SMSFs are allowed to borrow from a related party

The ATO states that the law does not prohibit the lender from being a related party. However, SMSFs must continue to comply with other legislative requirements. For example, the SMSF must satisfy the sole purpose test and comply with existing investment restrictions such as those applying to in-house assets and prohibitions on acquiring certain assets from a related party of the fund.

To know whether it is acceptable for related parties to lend to an SMSF on favourable terms, including 0% interest rates it is necessary to consider the full implications of the non-arm’s length income provisions in section 295-550 of the Income Tax Assessment Act 1997 (Cth).

Non-arm’s length income provisions

Broadly, income is non-arm's length income of a complying SMSF if:

• it is derived from a scheme or investment in which the parties were not dealing with each other at arm's length, and
• that amount is more than the amount that the SMSF might have been expected to derive if those parties had been dealing with each other at arm's length.

"Non-arm’s length income" is taxed at 45%.

ATO's position

The following comes from minutes of the June 2012 National Tax Liaison Group as tabled at the December meeting:

·        The ATO position on low rate loan arrangements and LRBA is that that they do not generally invoke a contravention of the SISA, do not give rise to non-arm’s length income under section 295-550 of the Income Tax Assessment Act 1997 (ITAA), do not invoke Part IVA of the ITAA 1936 and are not considered to give rise to contributions to the SMSF just from that one fact alone.

·        Taxpayer Alert 2012/7 was released on 20 November 2012 to warn SMSF trustees and advisors to exercise care to ensure any arrangements entered into by an SMSF to invest in property are the right investment for their SMSF and are properly implemented, particularly those involving LRBA or the use of a related unit trust. See also our earlier post: Beware! SMSF investing in Property

·        Issues and concerns of low rate loans and LRBA will be submitted to the review of borrowing. The ATO will be providing comments for the review when it commences.  This is likely to form part of the new Commonwealth Government's tax review although details are not yet to hand.

The ATO recently considered this in two private binding rulings (see 1012414213139 and 1012396819768). These rulings involved SMSFs that had 0% interest rate loans from related parties. In both the ATO concluded that the income derived was not non-arm’s length income which is positive news for those taxpayers. However, private rulings are not binding on the ATO and the full details are not always made public.

Take care and get a Ruling

Although limited recourse borrowing arrangements (LRBA) are becoming more common, care must be taken, especially with related party loans. Particular care should be taken in respect of non-arm’s length income given the tax consequences.

If an SMSF wants to engage in a related party borrowing transaction with favorable terms for the SMSF (ie, non-arm’s length terms) you must apply for a private ruling from the ATO and it is likely that such a ruling would only be applicable for 12 months.

It would not surprise us if in time s. 109 of the SIS Act (investment at arm's length) is amended to include related party loan transactions at market value.

Hockey & Sinodinos clear the tax backlog

couriermail.com.au

The Commonwealth government announced on 6 November 2013 that it would "scrap" a series of tax proposals introduced under the previous Labor government, including planned changes to the fringe benefits tax and moves to raise taxes on earnings from superannuation pension funds which it described as "unworkable".  Treasurer Hockey and Assistant Treasurer Sinodinos said this was the result of an audit of 96 unlegislated and unresolved tax and superannuation reforms dating back to 2001. Four of those proposals were dealt with by the coalition's plan to repeal the carbon and mining taxes, leaving a total of 92 proposals.

Key points:

• government will keep 18 of 92 unlegislated tax proposals
• remainder to be either dumped, amended or reviewed, a cost of $3.1b to the budget
• cap on self-education expenses dumped
• low-income superannuation tax offset linked to mining tax scrapped
• fringe benefits changes for car industry dumped
• government keeping Labor's tobacco excise increase, raising $5.3b for budget

SMSF trustees have welcomed the government’s decision to scrap the cap on tax-free income streams in retirement.

The Association of Superannuation Funds of Australia said dropping the mooted 15 per cent tax on annual superannuation earnings above $100,000 removed uncertainly around the retirement savings system. Critics noted that the decision to scrap this tax along with the Low Income-earners Super Contribution (LISC) unfairly targets Australia's lowest earners see for example the views of Industry Superannuation Association here.

Generally, commentators suggest that a wider review of tax is needed and that it must be tied to a national productivity agenda - see for example the comments from Stephen Martin of CEDA: VIDEO: CEDA's Professor Stephen Martin speaks with ABC News Breakfast (ABC News) 

The Institute of Chartered Accountants Australia today welcomed the government’s decision not to proceed with the $2,000 cap on the tax deductibility of self-education expenses.  Chief Executive Officer Lee White said today’s announcement was a win for common sense.  “The government must be congratulated for having the foresight to see that this was bad policy.  Education is the key to our economic prosperity and this cap would have hurt our productivity down the track,” he said.

The Institute said the government’s announcement related to companies looking to establish offshore subsidiaries is welcomed.  “The decision not to proceed with the repeal of interest deductions for companies borrowing to expand offshore will help make Australia an attractive place for international business,” Mr White said.

The government has indicated its intention to resolve all policies relating to the tax backlog by 1 December 2013 for inclusion in the Mid-Year Economic and Fiscal Outlook, with a view to legislation passing by 1 July 2014.  

Treasurer Hockey also announced that a tax White Paper would be commissioned such that proposed changes would be taken to an election.