The Australian Taxation Office (ATO) has, on a number of occasions over the last year, expressed its view that the non-arm's length income (NALI) provisions can apply where a trustee of a self-managed superannuation fund (SMSF) enters into a borrowing arrangement with a related party, and the terms of such arrangement are not consistent with those that could be expected from commercial dealings between parties acting at arm's length.
The effect of the NALI provisions applying is that income derived by an SMSF as a result of the non-arm's length scheme to which it is a party (for example, rental income derived from a property acquired using funds length by a related party) will be subject to an increased rate of taxation compared to the SMSF's other income (currently, a rate of 47%).
In line with its published views on the NALI provisions, the ATO has earlier this week issued a Practical Compliance Guideline (PCG 2016/5) in which a series of example terms of borrowing are set out that the ATO confirms will be accepted as reflective of an arm's length relationship if present in related party borrowing arrangements involving SMSFs (referred to in the Guideline as 'safe harbour terms').
Acknowledging that not all existing related party borrowing arrangements may be currently consistent with the safe harbour terms, the ATO also sets out a form of amnesty in the Guideline, noting its compliance approach to arrangements entered into by SMSF trustees before 30 June 2016.
In summary, the ATO states that it will not select an SMSF for review for the 2014-15 or earlier income tax years purely because an SMSF trustee has entered into a related party borrowing arrangement, provided the trustee takes steps to ensure that, by 30 June 2016, either:
- the terms of the existing arrangement are adjusted by the parties to be consistent with the safe harbour terms; or
- the existing arrangement is brought to an end (through repayment of the borrowings to the related party using funds of the SMSF or refinancing with a commercial lender).
If either of these conditions are satisfied, or an SMSF trustee acts in good faith to revise the terms of their existing borrowing arrangement before 30 June 2016 (but, for some reason, fails to finalise such revision by such date), the ATO assures SMSF trustees that the terms of their borrowing arrangement will not be subject to any further compliance action for years prior to 30 June 2015.
Gadens suggests that SMSF trustees take advantage of the safe harbour opportunity afforded by the ATO, through immediate review of any borrowing arrangement they have with a related party and ensuring any necessary steps are taken to modify existing terms prior to 30 June 2016 to avoid the application of the NALI provisions. Having been regularly involved in the establishment of related party borrowing arrangements, and acting for numerous commercial lenders in the implementation of arm's length arrangements involving SMSFs,