Late last week, the ATO released ATO ID 2014/39 and ATO ID 2014/40 which set out the ATO’s view that the non-arm’s length income (NALI) provision applies to the non-commercial LRBAs involving related parties in those cases.
“We are likely to apply scrutiny to related-party LRBAs where the terms of the loan, taken together, and the ongoing operation of the loan, are not consistent with what an arm’s length lender dealing at arm’s length would accept in relation to the particular borrowing by the fund trustee,” the ATO stated.
The ATO stated when it is assessing the nature of a loan, it will be taking into consideration factors such as the amount borrowed, the terms of the loan, and the loan-to-value ratio.
The ATO will also be looking at the nature of the acquirable asset and the interest rate that is charged – or other means by which the lender is compensated for the opportunity cost in lending the principal.
In addition, the regularity and frequency of principal repayments required will be examined, as well as the extent to which the loan has operated in accordance with its terms.
The ATO will also consider security taken for the borrower’s performance under the loan, given the limited recourse nature of the loan, such as mortgages and personal guarantees by SMSF members.
SMSF trustees entering into an LRBA with a related-party borrower should ensure they keep documentation that shows the terms of the loan and the ongoing operation of the loan are consistent with what an arm’s length lender dealing at arm’s length would accept, the ATO said.
“The matters listed above, taken together, would need to be shown to be consistent with what an arm’s length lender dealing at arm’s length would accept in relation to the particular borrowing by the fund trustee. Note that in relation to particular circumstances, there may be other matters that would also be relevant,” the ATO stated.
This guidance follows months of speculation initially stemming from a private binding ruling which showed the significant tax consequences that can potentially occur with nil-interest borrowings from related parties.