During the 2015/16 financial year, SMSFs were put on notice by the ATO that related party LRBAs needed to be on a commercial basis by 30 June 2016, with the ATO then extending this deadline until 31 January 2017.
The ATO said that if the loan was not considered to be on terms consistent with a commercial loan by the end of January, the ATO may then consider the income generated by the SMSF assets under the loan to give rise to non-arm’s length income, which is taxed at the top marginal rate.
The ATO provided guidance on this through PCG 2016/5, which set out the terms that must be met by the loan, for it to be considered an arm’s length dealing.
Speaking to SMSF Adviser, Hayes Knight director of SMSF, Ray Itaoui said by 31 January this year, SMSFs with non-bank LRBAs had to meet a certain level or requirements to be considered arm’s length, which included a certain interest rate amount, principal and interest repayments, and a loan to value ratio that did not exceed a certain level.
“We’re still seeing that a lot of these LRBAs are still not consistent with the safe harbour provisions,” said Mr Itaoui.
“What that can actually mean for the fund is that the income could actually be non-arm’s length income, so it will be taxed at the highest marginal rate. So that would include any income they’ve received from the property [under the LRBA] over the past few years.”
SMSF trustees are underestimating how important it actually is to have their loan consistent with the safe harbour provisions, he said.
In some cases, the SMSF trustees have actually made an attempt to meet some of the safe harbour provisions, he said, but they’ve missed some of the requirements or haven’t done it correctly.
“For an auditor it’s a real grey area, because if you see the loan paperwork, [but it’s not correct], you can't go back to the trustees or the accountant and say actually this is wrong, fix it, because it should have already been done by 31 January. So if they're changing it now, you know that it’s being backdated, and as an auditor you can't turn a blind eye,” he explained.
For SMSFs that have attempted to match their loan terms against a commercial loan on the market, SMSF trustees haven’t been able to provide enough evidence that it is consistent with what’s on the market, he said.
“No trustee has sat there and taken screenshots of what loans are available, on a particular day, for a certain amount and term,” he said.
“It just hasn't been done. People aren't thinking about it at the time that they're actually getting into these loans, it’s something they tend to do afterwards. They do it all, and then they decide to go back and try and fix it, but it’s usually too late.”
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