The ATO has issued guidelines defining the compliance obligations relating to limited recourse borrowing arrangements (LRBA) involving related parties that will ensure income from these strategies will not be treated as non-arm’s length in nature.
Practical Compliance Guideline (PCG) 2016/5 “Income tax – Arm’s lengths terms for Limited Recourse Borrowing Arrangements established by self-managed superannuation funds” outlines the specific conditions LRBAs within SMSFs must meet to avoid falling foul of the non-arm’s-length income rules.
The PCG, released in April, covers off safe harbour conditions for two scenarios – one where an LRBA is used to purchase real property and one where an LRBA is used to purchase a parcel of listed shares or units.
PCG 2016/5 Safe Harbour 1 stipulates that where an LRBA is used to acquire property, the interest rate that must be applied for 2015/16 is 5.75 per cent, the Reserve Bank of Australia’s (RBA) indicator lending rate for banks providing standard variable housing loans for investors, and for subsequent years must be this rate published by the RBA in May of that year.
Further, the interest rate used may be fixed or variable, but the term of a fixed interest charge may no longer exceed five years before reverting to a variable rate.
In addition, the term of an LRBA can now not exceed 15 years and the maximum loan-to-value ratio (LVR) is 70 per cent.
Repayments are to be made monthly and are to consist of a principal and an interest component, the ATO guideline stated.
When using an LRBA to purchase a bundle of shares or units, the applicable interest rate for 2015/16 must be 5.75 per cent plus 2 per cent.
For subsequent years, the interest rate used must be the one published by the RBA in May of the relevant year plus 2 per cent.
This scenario, Safe Harbour 2, also allows fixed or variable interest rates to be used, but the rate can only be fixed for a period of three years.
If fixed, the applicable interest rate must be 5.75 per cent plus 2 per cent with the official RBA rate announced in May, plus 2 per cent being applied beyond the three-year maximum.