Tuesday 16 December 2014
ATO rulings on LRBAs with zero interest loans
Tuesday 16 December 2014
The Australian Taxation Office (ATO) has issued two Interpretative Decisions (IDs) that consider whether income derived from limited recourse borrowing arrangements (LRBAs) involving related party lenders is non-arm's length income.
In ATO ID 2014/39, the trustee of a self managed superannuation fund (SMSF), who is also the trustee of a family trust, borrows several million dollars from itself (in its capacity as trustee of a family trust) through an LRBA at a loan to valuation ratio (LVR) of 100 per cent for 20 years with zero per cent interest. The loan is to be repaid in full at the conclusion of the loan term and there is no other security or guarantee placed on the loan.
In ATO ID 2014/40, the trustee of an SMSF borrows from the individuals who are both directors of the trustee company and members of the fund through an LRBA. The loan is approximately $500,000 at an LVR of 80 per cent for 15 years with zero per cent interest. The loan is to be repaid in monthly instalments over this period and there is no other security or guarantee placed on the loan.
While there are some differences between the two cases, the ATO’s view is that:
- in both cases, there is a scheme or arrangement whereby the SMSFs acquired a fixed entitlement to the income of the holding trust and income was earned as a result
the parties in both cases are not in an arm's length relationship and are not dealing with each other as arm's length parties would:
- in ID 2014/39 the reasons stated by the ATO include: no interest being charged nor any other means of compensation to the lender, no regular repayment of the loan was required, the 100 per cent LVR and no other guarantees were sought by the lender
- in ID 2014/40 the ATO stated the reasons to be: the high LVR (the members stated that third party lenders would typically only allow an LVR 60 to 70 per cent of the property value or require additional security) and the fact no interest or other means of compensation was being provided to the lender
- in both cases, the income derived by the funds is more than would have been achieved through arm's length dealings. The view expressed by the ATO is that if the party's were dealing with each other at arm's length the income derived would have been nil, as no money would have been lent by the lender and therefore no income earned.
The ATO's conclusion, in both cases, is that any income derived by the funds through the respective LRBAs will be considered non-arm's length income.
Following the release of these IDs, the ATO has also published further information on their website to assist in determining if non-arm's length income will arise from an SMSF entering into an LRBA with a related party borrower.
ATO Interpretative Decision ATO ID2014/39 Income Tax: non‐arm's length income ‐ related party non‐commercial limited recourse borrowing arrangement to acquire listed shares
ATO Interpretative Decision ATO ID2014/40 Income Tax: non‐arm's length income ‐ related party non‐commercial limited recourse borrowing arrangement to acquire real property