WHO SHOULD READ THIS
- Accountants, financial advisers and practitioners who assist clients with their SMSFs, and clients with SMSFs.
THINGS YOU NEED TO KNOW
- The ATO has clearly communicated that it will review non-bank LRBAs of SMSFs and enforce the personal use asset rules from 1 July 2016.
WHAT YOU NEED TO DO
- Clients with non-bank LRBAs should review their terms to ensure that they are arm's length in nature or they fall within the safe harbours provided by the ATO.
- Clients whose SMSF own a pre-1 July 2011 personal use asset should ensure compliance with the personal use asset rules before 30 June 2016 when the grandfathering provisions cease to have effect.
With all eyes on whether the Government will introduce changes to the superannuation system in the May Budget, care is still needed to ensure that your self managed superannuation fund (SMSF) complies with the existing law.
Two aspects of superannuation law which require attention by 30 June relate to non-bank limited recourse borrowing arrangements (LRBAs) and pre-1 July 2011 personal use assets.
Superannuation law allows a SMSF to borrow under a LRBA to acquire an asset. There is no restriction from whom a SMSF can borrow from the lender can be a third party such as a bank or a related party of the SMSF.
Initially the Australian Taxation Office (ATO) appeared to accept that a nonbank LRBA with a related party lender could be on terms which were extremely favourable to the SMSF. For instance, there was a perception that the ATO accepted that a related party loan to a SMSF could be interest free. However, in 2014 the ATO changed its position and came to a view that a related party loan to a SMSF which had non-commercial terms would trigger adverse income tax consequences for the SMSF (as expressed in ATO ID 2015/27 and ATO ID 2015/28).
The ATO's current view is that income which a SMSF derives from an asset financed by a non-commercial related party loan that is favourable to the SMSF constitutes non-arm's length income (NALI). A SMSF is taxed on any NALI that it derives at the top rate of 47% - this contrast unfavourably with the 15% concessionary tax rate normally applicable to a complying superannuation fund (which reduces to a nil rate with respect to income supporting a complying superannuation pension).
The ATO has also indicated that in determining whether or not a LRBA is arm's length depends on a review of all the terms of the loan and not just the interest rate alone. This position caused practical difficulties for SMSFs with related party loans since it was difficult to obtain the relevant financial information to prove the commerciality of their related party LRBAs. As a response to industry lobbying early on this month the ATO issued Practice Compliance Guidelines PCG 2016/5 which outlines safe harbour loan terms for related party LRBAs where the financed asset is either real estate or listed shares or units.
The ATO indicates that it will not review existing related party LRBAs where:
- the loan terms are the same as the safe harbour loan terms, and
- the SMSF makes principal and interest payments during the 2016 income year (i.e. by 30 June) which are consistent with such safe harbour terms.
The ATO has stated in a number of public forums that they will review non-bank LRBAs from 1 July 2016 and so now is the time for SMSFs with related party LRBAs to review and regularise them by 30 June.
Whilst one may quibble about the commerciality of the safe harbour loan terms with respect to a SMSF's particular situation, it is important to recognise that the ATO's position of allowing a SMSF to amend an overly generous LRBA to fall within the safe harbour rules is an accommodating stance. This is because there has always been an underlying concern that a non-arm's length LRBA could be affected by the NALI rule and, technically, if an arrangement is affected by the NALI rule then all the income derived from that arrangement is forever NALI and taxed at 47%. The ATO seems to suggesting that they will ignore past NALI issues if the SMSF meets the safe harbour rules by 30 June.
What are the safe harbour loan terms? The following table summarises the safe harbour loan terms:
Click here to view table.
The maximum LVR and loan term requirements contained in the safe harbour loan terms mean practically that a SMSF with an existing related party LRBA may have to make significant loan repayments by 30 June 2016. The ATO has provided little time for such a SMSF to marshall its resources to effect such loan repayments and so trustees of an affected SMSF should consider their position as soon as possible.
What are the options available to a SMSF with a related party LRBA in light of the release of the safe harbour loan terms?
A SMSF with a related party LRBA has the following options to choose from by 30 June 2016:
- review and restructure the loan terms to fall within the safe harbour loan terms
- obtain evidence from a finance expert of the arm’s length nature of their LRBA
- refinance with a commercial lender, or
- pay out the loan.
It is important to note that the safe harbour loan terms are only available where the financed asset is real estate or listed shares or units. Where the financed asset is something else (e.g. private company shares) then only the last three options are available.
A restructure of an existing LRBA to comply with the safe harbour loan terms will involve the trustees of the SMSF and the related party lender entering into a deed of variation to the LRBA loan document and the SMSF paying loan payments to meet the maximum LVR position. McCullough Robertson Lawyers can assist in drafting the required deed of variation and in calculating the loan payments needed to comply with the maximum LVR position.
Significantly, where a LRBA was entered into before 7 July 2010 care needs to be taken about the effects of restructuring to comply with the safe harbour loan terms. This is because the superannuation rules relating to pre-7 July 2010 LRBAs were more generous and allowed a SMSF to hold multiple assets in one LRBA and to use borrowed funds to develop or improve the financed asset. If the terms of such pre-7 July 2010 LRBAs are varied then they lose their concessionary grandfathered status and become subject to the current rules which only allow one asset per LRBA and prohibit the use of borrowed funds to develop or improve the financed asset.
Trustees of an affected SMSF should not procrastinate in this exercise because as discussed above the ATO has clearly indicated that they will devote compliance resources to reviewing non-bank related party LRBAs.
Grandfathering provisions for pre-1 July 2011 personal use assets ends on 30 June
Personal use assets comprise artwork, jewellery, antiques, antiques, artefacts, coins, wine, cars, recreational boats, memberships of sporting or social clubs and any non-land asset which is ordinarily used or kept mainly for personal use or enjoyment.
The personal use asset rules were introduced into superannuation law in a response to the May 2010 Cooper Review of superannuation which suggested that SMSFs should be prohibited from investing in personal use assets. This was because there was a concern that trustees of SMSFs were using superannuation funds to acquire personal use assets for their own personal enjoyment rather than for approved retirement purposes. Rather than ban SMSFs from investing in personal use assets the government decided to introduce rules that govern how a personal use asset can be owned and stored by a SMSF. The personal use asset rules apply to any personal use asset acquired by the SMSF on or after 1 July 2011.
Personal use assets held by a SMSF as at 1 July 2011 were grandfathered from the personal use asset rules until 1 July 2016. This grandfathering ends on 30 June and so it is important for SMSFs with pre-1 July 2011 personal use assets to ensure that they comply with the personal use asset rules in relation to such assets. The ATO has indicated that it will check that this is the case and monetary fines can be imposed on trustees for a failure to comply.
What are the personal use asset rules?
The personal use asset rules provide that:
- a personal use asset cannot be leased to or used by a related party (including by an informal licence)
- a personal use asset must not be stored in the private residence of a related party (including a garage or shed at a private residence) – although the ATO allows storage at the office of a related party provided the related party does not use it e.g. cannot hang the artwork on wall
- the trustee must document in writing their decision on asset storage and this must be kept for at least 10 years
- the personal use asset must be insured in the SMSF’s name within 7 days of acquisition (note there needs to be a separate insurance policy from a SMSF member’s house or business insurance policy), and
- if the personal use asset is sold to a related party then it is must be for a market value price determined by a qualified independent valuer.
If a SMSF breaches any of the above rules then a $1,800 monetary fine is imposed on each SMSF trustee (i.e. if there are two or more individual trustees then each of them is liable to pay a separate fine). It is also possible for breaches of a number of the above rules in which case multiple fines apply.
The ATO’s guide for SMSF auditors requires an auditor to sight the written storage decision document, any lease agreement, the insurance policy and any valuation report on disposal to a related party.