A superannuation fund generally cannot borrow, but s67A of the Superannuation Industry (Supervision) Act 1993 (SIS Act) permits superannuation funds to take ‘limited recourse borrowing arrangement’ (LRBA) to buy an ‘acquirable asset’ (and the asset is held by a separate trustee so the lender can only have recourse to that asset).
Self Managed Superannuation Funds (SMSF’s) are in a position to take limited recourse borrowings from related parties and this determination relates to the applicability of an anti-avoidance provision, which taxes ‘non-arm’s length income’ (NALI) at maximum marginal rates, instead of concessional rates: s295-550 of the Income Tax Assessment Act 1997 (ITAA97).
Subsection 295-550(1) gives the main definition of NALI as follows.
295-550(1) An amount of *ordinary income or *statutory income is non-arm’s length income of a *complying superannuation fund, … if:
(a) it is derived from a *scheme the parties to which were not dealing with each other at *arm’s length in relation to the scheme; and
(b) that amount is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm’s length in relation to the scheme.
It is possible to pump more value into a super fund, not only be ‘leveraging’ profitable asset acquisitions (the cap being only on contributions) but also by lending at a high loan to asset valuation ratio and to charge low (or no) interest on these loans.
Imbued by this ethic, some time ago, a number of tax practitioners floated the view that a nil interest rate on a LRBA could not produce NALI as it was an expense that was affected, rather than a receipt.
However, the ATO has given notice that it disagrees and on 28.9.16, issued this Determination to explain why a non-arm’s length LBRA can produce NALI.
The main reason is that the investment might have never been purchased if only an ‘arm’s length’ LBRA was available. For instance, a fund that had no other capital could not have bought the asset, if arm’s length gearing was limited to a 70% loan to asset ratio. On that basis, the Commissioner says that any investment income is more than would have been received if the asset was never acquired (because no arm’s length lender would have funded it).
There is a second reason, which the Determination doesn’t seem to deal with. There are some instances where it is not a gross receipt that is assessable but, rather, only the profit. Lower interest costs could swell the assessable profit (which might be ‘ordinary’ or ‘statutory’ income). This is probably not a very common scenario though.
At the same time as issuing this Determination, the Commissioner issued related Practical Compliance Guideline PCG 2016/5 (see next).
[ATO website – TD 2016/16] [LTN 188, 28/9/16]