In April 2016, the Australian Tax Office issued guidelines flagging that a limited recourse borrowing arrangement may have income derived from that arrangement, treated as non-arm’s length income (NALI), and hence taxed at 47%, if that limited recourse borrowing arrangement has been established or maintained on terms that are not consistent with an arm’s length dealing.
The NALI’s Provision will effect in a way that income derived by an SMSF as a result of the non-arm’s length scheme to which it is a party will be subject to an increased rate of taxation compared to the SMSF’s other income.
The ATO has earlier this week issued a Practical Compliance Guideline in which a series of example terms of borrowing are set out that the ATO confirms will be accepted as reflective of an arm’s length relationship if present in related party borrowing arrangements involving SMSFs Acknowledging that not all existing related party borrowing arrangements may be currently consistent with the safe harbour terms, the ATO sets out a form of amnesty in the Guideline, noting its compliance approach to arrangements entered into by SMSF trustees before 30 June 2016.
In summary, the ATO states that it will not select an SMSF for review for the 2014-15 or earlier income tax years purely because an SMSF trustee has entered into a related party borrowing arrangement, provided the trustee takes steps to ensure that, by 30 June 2016, either the existing arrangement is brought to an end or the terms of the existing arrangement are adjusted by the parties to be consistent with the safe harbour terms.
The ATO assures SMSF trustees that the terms of their borrowing arrangement will not be subject to any further compliance action for years prior to 30 June 2015 if either of these conditions are satisfied, or an SMSF trustee acts in good faith to revise the terms of their existing borrowing arrangement before 30 June 2016.
The ATO’s new approach if SMSF trustees do not want to pay 47% tax on income from an asset financed by an LRBA (by a related party), then they need to ensure that the terms of the LRBA are consistent with an arm’s length dealing. The ATO guidelines (PCG 2016/5) calls the requirements ‘Safe Harbour’ terms, on which SMSFs may structure their LRBAs to be consistent with arm’s length dealing, for income tax compliance purposes.