LRBA variation likely to trigger NALI
Changes to the terms of a related-party limited recourse borrowing arrangement due to COVID-19 are likely to set off the provisions surrounding non-arm’s length income, an SMSF auditor warns.
In a contributed blog, Naomi Kewley of Peak Super Audits noted that a related-party lender cannot vary the interest rate or extend the terms of their loan due to COVID-19 without jeopardising section 109 of the SIS Act relating to the principle of arm’s-length dealing.
“Changes in the interest rate or loan term are not currently being extended for real estate investment loans in the banking industry (though the term may be negotiated on a case-by-case basis). Concessions in rate and term are therefore not included in the ATO’s guidance for SMSFs,” Ms Kewley said.
“All principal repayments and interest may be deferred for six months due to COVID-19’s financial impact. The need for further relief must be reviewed at the end of this deferral period.”
As a result, Ms Kewley pointed out that SMSFs may have to make a large catch-up interest payment; however, that will depend on the commercial practice going forward.
Like related tenancies, Ms Kewley said an arm’s-length standard of dealing around LRBAs is essential to avoid compliance breaches and the incurrence of NALI.
She pointed to the Australian Banking Association’s commercial standard of dealing with real estate investment loans in a post-COVID-19 environment, whereby industry relief for these loans permits a deferral of principal repayments up to six months.
Further, interest will accrue on the loan over this period and must be caught up at a later point.
“As per its FAQ page, this is the ATO’s approved commercial benchmark for SMSF related-party borrowing,” Ms Kewley said.
“A related-party lender may therefore offer the same to their SMSF without jeopardising the principle of arm’s-length dealing (SIS section 109) and without giving rise to NALI.”