Acquiring property through a SMSF using limited recourse borrowing arrangements, or LRBAs, has become common practice. The ATO issued new guidelines because it was concerned some taxpayers may be using LRBAs to circumvent superannuation contribution caps and get more funds into the concessionally-taxed super environment.
They apply to SMSFs that do not choose bank finance and instead use a related-party loan to buy investment property. Trustees had until 31 January 2017 to comply with the new rules. Many trustees would have needed to change the terms of their arrangements; for example, either by ending the LRBA before that date, or refinancing through a commercial lender.
Where a LRBA with a related-party lender is established and the loan is not on commercial terms, (i.e. often on terms that could not be obtained from a bank such as lower interest rates, irregular repayments, or long loan terms) if the ATO considers it to be not an arms-length commercial arrangement, they can classify the income from this arrangement as non-arm’s length income. The consequences of this is that the income is subject to income tax at the top marginal tax rate of 47 per cent, instead of the concessional income tax rate of 15 per cent that ordinarily applies to SMSF income.
The ATO has outlined the conditions it expects a LRBA to meet in order for an arrangement to be considered arms-length. For a property investment, this includes:
- an interest rate equivalent to the Reserve Bank’s standard variable rate;
- a term of up to 15 years;
- a maximum loan-to-value ratio of 70 per cent; and
- monthly principal and interest repayments.
If an LRBA does not meet these safe-harbour requirements, the trustees must be able to demonstrate how the arrangement is at arm’s length.