Back in April this year, the ATO issued a “practical compliance guideline” regarding limited recourse borrowing arrangements (LRBAs) established by SMSFs.
The guideline (PCG 2016/5) set out when the Commissioner will accept that an LRBA is structured on arm’s length terms.
Following on from this guidance, the ATO has recently published further guidance on these matters in the form of a taxation determination released at the end of September (TD 2016/16). This replaced earlier guidance documents (ATOID 2015/27 and ATOID 2015/28 if you want to look them up), which have since been withdrawn.
The ATO says the new TD was issued following feedback it received after the issue of its practical compliance guideline in April, which also questioned how the non-arm’s length income (NALI) provisions apply in circumstances where an arrangement is not on arm’s length terms.
The approach adopted in the latest TD, the ATO says, “actually means that in some very limited circumstances, the NALI provisions may not apply to an arrangement, even though it’s not on arm’s length terms”.
However, the TD highlights that for the vast majority of cases, if there is an LRBA that is not on arm’s length terms, NALI will arise and the relevant income in the SMSF will be taxed at the highest marginal tax rate of 47%.
To avoid the possibility of the income being taxed at this high rate, SMSF trustees may want to take steps to ensure that any LRBA they enter into is on arm’s length terms. Such terms may be in line with the safe harbours provided in the ATO’s practical compliance guideline, or benchmarked against those offered by a commercial lender in the same circumstances.
“SMSFs contemplating an LRBA on non-arm’s length terms are strongly encouraged to seek independent professional advice, or to seek a private binding ruling from us,” the ATO says.
The release of this new taxation determination is in line with the ATO’s promise to release further LRBA guidance ahead of the new deadline of January 31, 2017, to ensure borrowing arrangements are compliant.
SMSF trustees are also advised that that can utilise the new ATO Let’s Talk page which is dedicated to the topic to access further information.