On 28.9.16, the Commissioner issued Practical Compliance Guideline 2016/5 offering practical guidance as to the terms on which related party ‘limited recourse borrowing arrangements’ (LBRA’s) without attracting audits for ‘non-arm’s length income’ assessments under s295-550(1) of the Income Tax Assessment Act 1997 (ITAA97).
It provides 2 ‘safe harbours’ – one for LBRA’s used to buy real estate and the other for buying listed shares.
Safe Harbour 1: The asset acquired is real property
6. Safe Harbour 1 applies when an SMSF uses an LRBA to acquire real property or to refinance a borrowing used to acquire real property, whether that property is residential or commercial premises (including property used for primary production activities).
7. The ATO accepts that an LRBA used to acquire real property, or to refinance a borrowing used to acquire real property, is consistent with an arm’s length dealing if the terms of the borrowing are established and maintained throughout the LRBA as set out below.
|Interest Rate||Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors. Applicable rates:
|Fixed / variable||Interest rate may be variable or fixed
The fixed rate is the rate published for May (the rate for the May before the relevant financial year).
The 2015-16 rate of 5.75% may be used for LRBAs in existence on publication of these guidelines, if the total period for which the interest rate is fixed does not exceed 5 years (see ‘Term of the loan’ below)
|Term of the loan||Variable interest rate loan (original) – 15 year maximum loan term (for both residential and commercial)Variable interest rate loan (re-financing) – maximum loan term is 15 years less the duration(s) of any previous loan(s) relating to the asset (for both residential and commercial)
Fixed interest rate loan – a new LRBA commencing after publication of these guidelines may involve a loan with a fixed interest rate set at the beginning of the arrangement. The rate may be fixed for a maximum period of 5 years and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 15 years.
For an LRBA in existence on publication of these guidelines, the trustees may adopt the rate of 5.75% as their fixed rate, provided that the total fixed-rate period does not exceed 5 years. The interest rate must convert to a variable interest rate loan at the end of the nominated period. The total loan cannot exceed 15 years.
|Loan to Market Value Ratio (LVR)||Maximum 70% LVR for both commercial and residential propertyIf more than one loan is taken out to acquire (or refinance) the asset, the total amount of all those loans must not exceed 70% LVR.
The market value of the asset is to be established when the loan (original or re-financing) is entered into.
For an LRBA in existence on publication of these guidelines, the trustees may use the market value of the asset at 1 July 2015.
|Security||A registered mortgage over the property is required|
|Personal guarantee||Not required|
|Nature & frequency of repayments||Each repayment is of both principal and interestRepayments are monthly|
|Loan agreement||A written and executed loan agreement is required|
Safe Harbour 2: The asset acquired is a collection of stock exchange listed shares or units
8. Safe Harbour 2 applies when an SMSF uses an LRBA to acquire a collection of shares in a stock exchange listed company or to acquire units in a stock exchange listed unit trust. Safe Harbour 2 also applies when an SMSF uses an LRBA to refinance a borrowing used to acquire such a collection.
9. The ATO accepts that an LRBA used to acquire or to refinance a borrowing used to acquire stock exchange listed shares or stock exchange listed units in a unit trust is consistent with an arm’s length dealing if the terms of the borrowing are established and maintained throughout the LRBA, as set out in a table very like the one above.
The key differences are as follows.
- The interest rate is 2% points above the rates above the housing loan rates above.
- The interest rate can be fixed for no longer than 3 years (instead of 5 years).
- The term of the loan must be no more than 7 years (not 15 years).
- The loan to valuation ratio must not exceed 50%.
[ATO website – PCG 2016/5] [LTN 188, 28/9/16]