The ATO has clarified its approach to the application of Practical Compliance Guidance (PCG) 2016/5, which stipulates the safe harbour conditions for limited recourse borrowing arrangements (LRBA), confirming the parameters defined in it are not considered definitive as to whether the non-arm’s-length income (NALI) rules apply for this type of gearing strategy.
During a question and answer session for SMSF Association members, ATO acting deputy commissioner Paul Delahunty noted it was critical for auditors and trustees to first understand the role the regulator sees PCG 2016/5 playing so as to be able to appreciate what complying with the instrument really means.
“The purpose of the guideline [is that] it sets out the safe harbour terms on which SMSF trustees may structure their LRBAs to be consistent with an arm’s-length dealing. What that means, in terms of the income tax compliance process, is the commissioner will accept an LRBA that is structured in accordance with the PCG will be consistent with an arm’s-length dealing and that the NALI provisions do not apply purely because of the terms of the borrowing arrangement,” Delahunty said.
He then explained what this means in the context of a commercial loan agreement implemented at an interest rate lower than that prescribed in the guidance.
“Equally important there is that for SMSF trustees who have entered into an arrangement which does not meet all of the safe harbour terms, which obviously extends beyond just the interest rate that is set out in the PCG, it doesn’t mean the arrangement is then deemed to not be on arm’s-length terms,” he indicated.
“I think a lot of questions that are asked [about LRBAs] form an assumption that because the PCG isn’t met, the arrangement will not be on arm’s-length terms [and that is incorrect].
“What it does mean is that in those situations there is no certainty provided to the trustees under the PCG. That means the trustee won’t have the assurance that the commissioner will accept the arrangement they have entered into is consistent with an arm’s-length dealing.”
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