It looks like trustees will now need to revisit limited resource borrowing arrangements under new rulings by the Australian Taxation Office.
Before we look at the recent developments, let’s just re-cap of how super funds can borrow for investment purposes:
- You’re fund can invest in another vehicle that contains gearing – for example, a company. There are restrictions in place if that other entity is controlled, or deemed to be controlled, to you or your relatives or some of your business associates.
- Your fund itself borrows money to purchase an asset. To comply with the law, the asset must be held in a Holding Trust and the loan must not allow any recourse against your super fund’s other assets. This structure is called a Limited Recourse Borrowing Arrangement or LRBA.
Change to Government tax legislation
Earlier this year, the Parliament passed tax laws that impact how these super funds are taxed.
For many years, it hasn’t been crystal clear that many of the income tax issues, including capital gains taxes, would be imposed on the ultimate owner of the asset held in LRBA Holding Trusts and other similar investment structures.
This new legislation seeks to clarify this point.
These new rules have been many years in the making – they were first announced in the 2010 Federal Budget and apply from 1 July 2007.
Related Party Lending
One of the more interesting features of LRBAs is that there is no requirement for the lender to be a bank or other financial institution.
In fact the lender could be you or entities such as companies and trusts that are related to you.
Suppose you run your own business via a company and it owns your business premises without any debt. You might decide that your super fund is a better place to hold this asset, but the problem is that your super doesn’t have enough money to buy the premises outright.
So you solve this by getting the super fund to pay some of the purchase price and your company loans your super fund the remainder via vendor finance.
The premises would be held in a Holding Trust under the LRBA rules already mentioned.
Just some background information here:
- There can be some tricky issues to sort out here – purchase price, transaction costs including stamp duty, capital gains tax on disposal by the company and so on; and
- Your super fund can only acquire certain types of assets from you or your related parties. Premises used wholly and exclusively in the running of a business or listed shares are two common examples.
The key issue here is the terms of the company’s loan. There is nothing strict here and this is where life can get a bit complicated.
There are two aspects– one is the super laws and the other is the tax laws.
Let’s look at the super laws first – under the super laws, it is a requirement that fund trustees mustn’t enter into any transaction that would see the super fund lose out and pay more than it could obtain on the open market.
For example, suppose your company decided to charge an interest rate of 30% per annum. This is clearly way over current market conditions and would be a breach of this rule.
But this law doesn’t prevent the super fund from receiving an outrageously good deal. For example, what about a 0% interest rate with no requirement to repay the loan, which has an indefinite term?
Are these possible?
Yes, they are under the super laws.
Now we come to the tax laws. In the tax laws that apply to a super fund is a provision called Non-Arm’s Length Income or NALI.
This law says that certain types of income will be taxed at 47%, not the normal concessional rate of 0% for pension income or 15% for all other income. This rule includes any income paid from a discretionary trust – such as your family trust – and potentially from companies and fixed trusts that are related to you.
There is a range of tests here, but would NALI apply to the fantastic loan conditions suggested above?
There are some who argue no, and for a while, the Australian Taxation Office agreed (ATO). It issued some Private Binding Rulings to some taxpayers. These rulings are binding on the ATO, unless the government specifically changes the relevant NALI tax laws. Good luck to you if you have one of these rulings!
Of great importance to most of us is the fact that last year, the ATO changed its mind and said that NALI would apply. It said this applied under old tax rules.
It has now looked again at this issue, taking into account the new tax laws that were passed earlier this year that I referred to above. It says that NALI still applies.
This ATO view is quite controversial and it may be that in time, at least one taxpayer will take the matter to a Tribunal or Court.
What do you do if you have a non-arm’s length LRBA that doesn’t have a Private Binding Ruling?
The ATO have announced that it will not take any action on super funds with these arrangements as long as they have re-organised these arrangements by 1 July 2016 and placed the borrowings on an arm’s length basis. If this impacts you, then you should consider seeking advice to ensure you change the loan’s terms to place it on an arm’s length footing.
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.