SMSFs face hefty tax bills for uncommercial lending

Trustees of self-managed superannuation funds (SMSFs) are being urged to ensure limited recourse borrowing arrangements (LRBAs) related party loans are proved on commercial terms to avoid substantial tax bills. 

Townsends Business and Corporate Lawyers warned that income derived from rent, dividends, interest and capital gains/losses related to investments associated with LRBAs could be taxed at 45 per cent or higher, if the Temporary Budget Repair Levy was applied. 

The legal experts warned that the potential tax bill from such arrangements could call into question whether the trustees of the SMSF behind the loan had acted in the best interests of fund members by entering into an LRBA. 

However, the ATO has indicated that it takes a holistic view of the loan arrangement and the use of one (or possibly more) of these terms in conjunction with other commercial terms (e.g. nil interest rate, but with a more commercial LVR and loan period) may not necessarily result in the SMSF having to pay special income taxation on the derived income.   

However what combination of these terms would be approved by the ATO seems to only be determined on a case by case basis at the moment and no further guidance has been provided. 

Brian Hors, special counsel for Townsends Business and Corporate Lawyers, said SMSF trustees should only engage in LRBAs if they used terms similar to commercial lenders. 

“We often suggest that for clients mimicking commercial lender terms that they keep documentation (e.g. Lender’s brochure, website print out, loan offers) demonstrating these terms, to provide to an auditor or the ATO in the future,” he said. 

Townsends recommended that those with current related party loans in place should review their loan terms to ensure they are commercial, but warned that any variation needed to be properly documented by the parties. 

“With the increased penalty regime of the ATO starting on 1 July 2014 it would be appropriate to review these loans before the starting date as the ability of the ATO to impose a fine will apply to existing non-compliance after that date” the firm said.