Lend to your fund at a low interest rate

SMSF technical expert and columnist for The Australian newspaper
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Believe it or not, it’s possible for you to lend money to your super fund at a very low interest rate. But while it sounds like an attractive proposition for funds that may be looking to purchase a large asset, the transaction needs to be made with extreme care.

I first introduced you to this concept a few weeks ago in: Yes, you can sell and asset to your super fund for $1 and What assets can I sell to my super fund?. Today, I’ll delve into the process of charging low rates to your fund.

Lower than market rate

Charging a very low interest rate on Limited Recourse Borrowing Arrangements (LRBAs) is a controversial topic. The low interest rate arises when a related party of a super fund loans money to the fund at a rate that is much lower than a super fund would be able to get from banks and other financial institutions for LRBA purposes.

Charging a low interest rate raises at least four issues: the super arm’s length rule, the deemed contribution provisions, the deemed dividend provisions, and the general anti-avoidance provisions.

Arm’s length rule

A few weeks ago I discussed the super arm’s length rule. In that article I explained that you can satisfy this rule by making sure the super fund isn’t charged an interest rate that is higher than the prevailing market rate. In other words, the super fund isn’t losing out. In such a circumstance, the arm’s length rule won’t be an issue.

Is it a contribution?

The second issue is the deemed contribution provisions of the super laws.

Tax Ruling 2010/1 says that when a super fund acquires an asset for less than its market value, the difference between that market value and the actual purchase price is deemed to be a super contribution. This needs to be reported and assessed for excess contributions tax purposes because that capital of the fund has increased.

Now, if you think the ruling applies to low interest rates on LRBAs, then you would be wrong. Industry representatives of the National Tax Liaison Group Superannuation Technical Sub-committee recently asked the Australian Tax Office (ATO) for its views.

Surprisingly, the ATO said that charging a low interest rate didn’t increase the capital value of the fund. One proviso with this view is that there must be an LRBA loan in place with appropriate documentation, including the obligation to repay the loan.

It would appear that if you personally borrow $1 million at 7% and then you lend it to your SMSF with appropriate documentation at 0% then, even though you’re effectively making a $70,000 payment to the super fund, in the ATO’s view, you haven’t made a contribution.

In this case, your interest cost on the borrowed money isn’t tax deductible. On the other hand if the fund borrowed the money and you paid the interest cost, it would be a deemed contribution. Additionally, if you lent the $1 million to the fund at 7%, but forgave that interest cost, then it would also be a deemed contribution.

Dividend provisions

The third issue is the deemed dividend provisions. These provisions attempt to make sure that private companies don’t make tax-free distributions to shareholders or their related parties.

Loans or other payments to shareholders are deemed to be dividends. If one of your companies loans money to your super fund at a low interest rate, then this would be classed as a deemed dividend and taxed accordingly.

Anti-avoidance

The fourth point is the general anti-avoidance provisions. Some experienced super lawyers say loaning money to a super fund at a low inter¬est rate instead of the market rate could look like a ‘scheme’ to avoid tax. The ATO might deem the lower interest costs for the super fund to be a tax benefit.

If you want to enter into a low interest rate loan with your super fund, I suggest you apply for a Private Binding Ruling and ask the ATO to look at all the relevant tax rules that impact you. Your fund should also apply for ATO SMSF Specific Advice and ask them to examine the super law provisions. This way you can be sure you and the ATO are on the same page.

Important information: 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. Anyone should consider the appropriateness of the information in regards to their circumstances.

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