The ATO has provided further guidance regarding limited recourse borrowing arrangements (LRBAs) and when non-arm’s length income (NALI) rules apply to a related party LRBA.
The Tax Office recently released a Taxation Determination (TD 2016/16) and updated its Practical Compliance Guideline (PCG 2016/5) to provide further clarification concerning the circumstances where a self-managed super fund (SMSF) with a related party LRBA would attract a higher marginal tax rate of 47 per cent under NALI provisions.
The ATO will continue to use the “safe harbour” terms for LRBAs set out in PCG 2016/5. The “safe habour” terms are designed as a safety net for SMSF trustees to ensure their LRBAs meet the guidelines.
Limited recourse borrowing arrangements (LRBAs) must be sustainable on normal commercial rates and structured in accordance with the ATO’s “safe harbour” guidelines to ensure the NALI provisions (47 per cent tax) do not apply.
Furthermore, the Tax Office will assess whether an arrangement was on arm’s length terms by assessing if the SMSF has derived more ordinary or statutory income under the scheme then it might be expected to derive if the parties had been dealing with each other on an arm’s length basis.
The ATO will assess what the terms of the borrowing arrangement may have been if the parties were dealing with each other at arm’s length (hypothetical borrowing arrangement). It is then necessary to establish whether it is reasonable to conclude that the SMSF could have and would have entered into the hypothetical borrowing arrangement.
If the SMSF could not have or would not have entered into the hypothetical borrowing arrangement, the SMSF will have derived more ordinary or statutory income under the scheme than under the hypothetical borrowing arrangement. In this instance, the ordinary or statutory income derived is NALI.
SMSF trustees have until 31 January 2017 to ensure they meet the “safe harbour” terms set out in the Practical Compliance Guideline (PCG 2016/5).