In an update to its guidance on the SMSF FAQ page, the ATO recognised that SMSF landlords may be seeking LRBA relief due to the financial effects of COVID-19, stating that:
If the repayment relief reflects similar terms to what commercial banks are currently offering for real estate investment loans as a result of COVID-19, we will accept the parties are dealing at arm’s length and the NALI provisions do not apply. For example, these terms currently include temporary repayment deferrals for most businesses of up to six months, with unpaid interest being capitalised on the loan.
The parties to the arrangement must also document the change in terms to the loan agreement and the reasons why those terms have changed. It is also expected that there is evidence that interest continues to accrue on the loan and that the SMSF trustee will catch up any outstanding principal and interest repayments as soon as possible.
Any further repayment relief needed due to the continued effects of COVID-19 should be reviewed at the end of the agreed deferral period and remain in line with what the commercial banks are offering at that time.
Conditions and potential traps with loan relief
In a blog, Cooper Grace Ward Lawyers partner Clint Jackson said that although the ATO announcement is useful, practically it will only provide SMSF borrowers with short-term cash flow relief during the current crisis.
Further, the guidance does not allow a related-party lender to provide the following relief (unless there is independent evidence from a commercial lender) for an LRBA loan:
- extension to the loan term
- change to the interest rate
“As the terms of the loan will generally not be able to be extended, after the deferral period is over, the SMSF borrower will have to make bigger monthly repayments for the loan to be repaid in full by the end of the loan term,” Mr Jackson said.
Because of this, Mr Jackson said there are some conditions and potential traps should a related-party lender provide relief to an SMSF from loan repayments.
For related-party loans, he said the ATO will only accept that the loan relief will not trigger the non-arm’s length income (NALI) rules where the relief provided is consistent with what a commercial bank is currently offering.
Relief provided will be consistent with that offered by commercial banks where:
- It can be established through independent evidence that a commercial bank would have provided the same relief.
- The relief provided is consistent with the relief packages published on the Australian Banking Association’s website.
Mr Jackson said that the Australian Banking Association currently provides that lenders will provide a deferral of loan repayments for up to six months on the following basis:
- Interest will continue to be accrued during the deferral period.
- Accrued interest is to be capitalised and form part of the amount to be repaid.
- The borrower must be able to show they have been financially impacted by COVID-19.
- The borrower must not terminate a lease or evict a tenant for rent arrears during the loan deferral period.
In addition, Mr Jackson said the ATO’s announcement does not extend to related-party loans to a unit trust where the SMSF is a unitholder.
“This is really disappointing, given the same non-arm’s length income issues arise in this situation,” he said.
“Even though the ATO’s announcement is specifically limited to LRBAs, it is our view that a related-party lender can provide the same relief to a unit trust borrower. This is because the relief permitted by the ATO is linked to what a commercial lender would provide in the circumstances.”
For loans from related parties to SMSFs that must also comply with Division 7A terms, Mr Jackson said the ATO has indicated that they are still reviewing their position on this, given the current lack of equivalent relief from Division 7A.
As a result, such loans must continue to satisfy these requirements, which include making the minimum yearly repayment.
Where a related-party loan to an SMSF for an LRBA must also comply with Division 7A, Mr Jackson said this means:
- The related-party lender can provide relief by deferring the monthly principal and interest repayments.
- [But] before the end of the financial year, the total repayments made on the loan must still be at least the minimum yearly repayment required by Division 7A.
