Rate rises can impact loan requirements for related party loans, warns expert
Trustees need to factor in rate rises if they have a related party loan to ensure they meet compliance around minimum loan repayments, says an expert adviser.
Chris Reed, SMSF specialist advisor and director of Business Concepts Group, said in a recent podcast that there can be several flow-on effects to an SMSF if loan agreements are not refreshed or kept up to date.
“Most trustees are aware that SMSFs do have the capacity to borrow and that they don't just have to borrow from a mainstream lender, that you can borrow from a related party,” Mr Reed said.
“However, there are additional compliance requirements if you are borrowing from a related party, including complying with the terms of the loans such as correct interest rates and repayments.”
Mr Reed said the safe harbour provisions from the ATO have a maximum 15-year life period and there are interest rates that are specified by the ATO.
“You can have a fixed interest rate period under that maximum of five years, but you need to make sure you are applying the correct interest rate to stay within the safe harbour rules,” he said.
“You also need to make sure you’re making the correct loan repayments to ensure that the loan goes no longer than 15 years.”
Mr Reed said he has had a few cases recently where the loan was fixed originally and the fixed period had expired but the trustees had not reset the repayments to be based on the new interest rates that were in place.
“That flows on and creates a compliance headache around the fund and what to do around trying to calculate how short the payments were and what to do about the short payments,” he said.
“It means talking to the fund auditor and the ATO about what sort of catch-up payments are required as well as perhaps looking into default or penalty interest and it can get quite messy trying to rectify that.”
Mr Reed said the regular rate increases have meant that the ATO would have reset the specific rate required under safe harbour rules each June, and the most recent rise was around 3 per cent.
“It was a significant increase and if you weren't on a fixed term within your SMSF LRBA then you’ve got to account for that extra interest within the fund, which means repayments would have been a lot higher as well,” he said.
“If you do have a related party LRBA, it’s important to understand the terms of the loan agreement and stay on top of it, whether you fix it for two years or five years you need to know when that date does refresh and look up the safe harbour rate.”
He added it could mean recalculating the loan agreement and schedule to ensure that it is paid off within the 15-year limit.
“From an SMSF point of view, it also means looking at cash flow, and making sure that you're going to be able to meet those loan repayments,” he said.
“Some funds may have a bit of cash flow pressure with those extra repayments especially if you are in a fixed agreement with a tenant and you've got your rent set.”
If there is a cash flow problem, he said it may mean the loan needs refinancing, potentially with a mainstream lender.
“A disaster scenario would be the property needing to be sold, which is not what anyone would want in the fund,” he said.
