Charging a low (or zero) interest rate on a super fund loan might lead to some high penalty rates in your super fund following a recent Private Binding Ruling released by the Australian Taxation Office.
The loans allowed in SMSFs are Limited Recourse Borrowing Arrangements or LRBAs. There are all sorts of rules governing these transactions and they’re quite easy to muck up. Good advice is essential when you set these structures up, when you’re running one and when you want to unwind them.
In August 2012 I wrote about your ability to personally loan money to your super fund as part of an LRBA at a very low interest rate. You can read that article here.
The information from that article came from questions super industry representatives had submitted to the ATO via a liaison committee that has since been disbanded.
One of the points I made in the 2012 article, was that if you want to use a low interest rate LRBA, with you as the lender, then you should consider applying for a Private Binding Ruling (PBR) from the Tax Office.
Some people seem to have followed my suggestion because over the last 20 months or so the Tax Office has published some PBRs about this topic.
Low interest loans and non-arm’s length income (NALI)
When a super fund receives NALI, it pays 46.5% tax on that income or realised capital gains. All income or capital gains distributed from a discretionary trust (that is, any trust that gives the trustee any discretion on how to distribute income or capital) will always be deemed to be NALI.
The situation for distributions from companies and all other trusts isn’t so clear. For these entities, NALI will typically occur when a super fund investment isn’t continually based on normal arm’s length principles. For example, a super fund might have paid a discount for its investment in an entity or received a distribution that didn’t equate to its investment. In other words, the super fund and the entity weren’t dealing at arm’s length.
Until recently, the PBRs that have been issued about low interest rate LRBAs have stated that in the Tax Office’s view, NALI doesn’t apply.
The ATO took the view that NALI didn’t arise because the income received by the super fund from the LRBA asset when a low interest rate was being charged wasn’t greater than the amount of income it would have been paid on an arm’s length basis, and the super fund wouldn’t face 46.5% tax on the income it receives from the LRBA asset.
New ruling
In the last month the ATO has changed its tune in relation to a zero interest LRBA involving real estate. The ATO stated in one PBR that NALI will apply because:
- If the interest rate on the loan was greater than zero then the super fund wouldn’t have borrowed the money and hence wouldn’t be receiving any income on the potential investment. That is, the rent isn’t an arm’s length amount.
- The net rent received by the super fund would have been lower if an interest rate greater than zero had been charged.
I know many SMSF practitioners who don’t agree with this new interpretation.
There have been media reports that a PBR like this has been appealed to the Courts. It’ll be interesting to see if this action leads to a hearing and published judgement (most tax cases are settled out of the public eye).
In any event it will take some time before this issue is fully clarified.
So if you have a nil interest LRBA in place and no PBR on foot, then I suggest you consider getting one now. (Be aware however that the PBR might not be favourable.) If you are interested in putting in place a low interest LRBA then I still suggest you consider getting a PBR before proceeding. One of the key issues for you will be the wording of your loan agreement and the super fund’s rights as the sole beneficiary of the Holding Trust. As always it pays to get good advice.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
