SMSFs flagged on Div 7A relief implications from ATO’s updated guidance

The Tax Office recommended the guidance if an SMSF has an LRBA from a related private company where Division 7A applies and there has been negotiated repayment relief with the lender on commercial terms as a result of the financial impacts of COVID-19.

Speaking at a recent DBA Lawyers webinar, senior associate William Fettes said the updated guidance does confirm how parties now might proceed, subject to some of the qualifications when obtaining the Division 7A administrative relief.

“Basically, the gist of it is the effect on where you’ve had a deferral of loan payments due to COVID-19,” Mr Fettes said. 

“Provided that’s been consistent with arm’s length dealings whether we’ve had a loan term that’s perhaps been varied or had an interest that’s capitalised on the LRBA loan which may not gel with Div 7A requirements, then we’re going to still have comfort that there’s not going to be a negative consequence there.

“Essentially, we’re going to have comfort that the unpaid amounts on the LRBA loan won’t be taxed as unfranked dividends and we won’t get non-arm’s length income consequences.

“It is important to realise that is the administrative relief guidance the ATO has provided where essentially there has been COVID relief applied to an LRBA loan to a related entity that’s subject to Div 7A complying loan requirements.”

But while the guidance sets in relief in broader terms, advisers will need to prepare for certain practical elements surrounding the COVID-19 relief and its implications on the SMSF, according to Mr Fettes.

One of the key issues advisers need to sharply focus on is where the Div 7A relief already applied from FY20, the impacts will affect the cash flow in terms of the minimum yearly repayments.

“There’s a bit of stipulation with it; however, essentially, we do need to just make sure that it’s not just carte blanche in relation to COVID-19 where we are going to have repayment relief,” Mr Fettes explained.

“There has to be some evidence there that any variation to the terms of the loan is essentially going to reflect what commercial banks would be doing in relation to real estate investment loans at the time.

“There needs to be that sort of evidence in relation to what has actually happened and it’s also going to need to be documented appropriately in terms of what the changes were to the loan agreement and the reasons for those changes essentially linking it back to COVID-19.”

In terms of the process, Mr Fettes noted there needs to be evidence that interest continues to accrue on that loan, and at the end, the trustee will repay any deferred principal and interest repayments in relation to the varied terms.

“So, it’s important to remember you’re still on the hook in relation to that deferred amount because that means it’s not just the double-up on the repayments, but there’s also the interest factoring into it,” he said.

Furthermore, when referencing the guidance, Mr Fettes said it does spell out the ATO’s position that it will be looking more closely at that repayment relief and whether there is the capitalisation of the interest on the loan.

“Essentially, they’re going to say we need to see a complying loan agreement that the SMSFs met the minimum yearly repayment or has applied for the administrative relief,” he said.

“You do have to apply for that relief if you’re unable to meet those minimum repayments and that there’s a link between the repayment relief and the effects of COVID-19, and it’s effectively the same as what commercial banks were doing in the same context.

“If you can satisfy those requirements, then this administrative relief is going to be a positive one.”