Q: My self-managed super fund includes a property purchased using a related party limited recourse borrowing arrangement. I have been told that I must adjust the interest rate on the loan to company with tax office guidelines for ensuring that my LRBA is structured on a bona fide arm’s length basis. Can you confirm this?
A: Yes, SMSF trustees using related party limited recourse borrowing arrangements to acquire property or shares will have to adjust the interest rate on their loans to remain within Australian Taxation Office safe harbour guidelines.
The variable interest rate for real property goes up from 5.65 per cent in 2016/17 to 5.8 per cent in 2017/18.
For fixed-term rates trustees may choose to fix the rate at the commencement of the arrangement for a specified period, up to a maximum of five years.
For listed shares or managed investments, the safe harbor rate is the rate for property plus 2 percentage points – so 7.8 per cent for 2017/18.
Following changes to regulations last year, trustees have had to maintain their related party loan arrangements on an arm’s length basis or risk paying penalties on the income from the investment.
The ATO issued safe harbor rules to help trustees meet their obligations. The interest rate is based on the Reserve Bank indicator lending rate for banks providing standard variable housing loans for investors and is reset each year.
Borrowing arrangements that meet all the safe harbour terms will be deemed consistent with the arm’s length dealing provisions of the Income Tax Assessment Act.
Real property. Apart from the interest rate, loan terms can only be up to 15 years, the maximum loan-to-valuation ratio is 70 per cent, a registered mortgage is required, repayments must be principal and interest and must be monthly.
Shares or managed investments. Loan terms can only be up to seven years, the maximum LVR is 50 per cent, security is required, payments must include principal and interest and must be made monthly.
The ATO says that if trustees have entered into an arrangement that does not meet all the safe harbor terms, it does not mean that the arrangement is deemed not to be on arm’s length terms. But it does mean that the trustees cannot rely on the certainty provided by the sage harbor guidelines.
“Trustees will need to be able to otherwise demonstrate that the arrangement was entered into and maintained on terms consistent with arm’s length dealing,” the ATO says.
The rules apply to all LRBAs, including those that were set up before the rules took effect in January.