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As approximately 10% of self-managed superannuation funds (SMSFs) have used limited recourse borrowing arrangements (LRBA) to purchase assets, it’s likely a significant number may have taken advantage of COVID-19 repayment relief offered by lenders.
Even if the repayment relief has ended, trustees need to understand and document what was offered, especially if the loan was from a related party.
What relief is available?
During COVID-19 and the subsequent lockdowns, some trustees with LRBAs may have faced cash flow issues and difficulty meeting loan repayments for a variety of reasons. They may have offered rent relief to a tenant of a property asset; they could have experienced reduced income due to COVID-19 market volatility; or they may just have seen superannuation contributions to the fund fall if a member lost their job.
Speaking at the SMSF Association annual conference, Phil Broderick, principal at Sladen Legal, explained some of the detail surrounding COVID relief available to SMSF trustees for their LRBA loans.
“More commonly what would be considered to be relief in the COVID-19 sense is freezing of principal and/or interest,” he said.
The main issue with repayment relief of any sort would be the potential for it to trigger non arm’s-length income (NALI) if the lender was a related party. NALI is taxed at the highest marginal rate.
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The ATO’s position
The Australian Taxation Office (ATO), in response to a question on whether or not repayment relief for LRBA’s would trigger NALI, said last year:
If the repayment relief reflects similar terms to what commercial banks are currently offering for real estate investment loans as a result of COVID-19, we will accept the parties are dealing at arm’s length and the NALI provisions do not apply. For example, these terms currently include temporary repayment deferrals for most businesses of up to six months, with unpaid interest being capitalised on the loan.
The ATO then refers SMSF trustees to the Australian Banking Association’s (ABA) website for current information on COVID-19 bank relief. At the end of an initial six-month deferral the ABA also allowed an additional deferral period of four months if a loan could not be restructured.
But the ATO does have requirements for the relief. Namely:
- Changes to the LRBA must be documented
- Interest on the loan is expected to accrue and be capitalised
- There is the understanding the SMSF will catch up on payments as soon as possible.
Create a paper trail
Broderick said the best form of documentation for the relief would be a formal deed of variation varying the loan terms.
“[You] should also keep documentation about the financial impact COVID-19 has caused to the SMSF… If the tenant is a pub, perhaps even having newspaper articles about how all the pubs were shut down during lockdown, I think would be advantageous.”
If relief is sought beyond what the ABA has allowed, SMSFs will need to keep benchmarking material and evidence to show that the relief given the SMSF matches what other commercial entities are offering.
“If we are relying on some of these ATO measures that are only contained on websites then I would be taking, and certainly recommending, that you print out or take a screenshot of those website materials,” Broderick said.
Does COVID relief affect safe harbour protections?
There is also the implication in the ATO’s statement above that the COVID relief will not result in the loss of safe harbour protections as detailed in Practical Compliance Guideline PCG 2016/5.
There are some extra considerations if the lender under the LRBA is a related company or a related trust that has an unpaid present entitlement owing to a company (directly or through a chain of trusts). Such loans must take into account the operation of Division 7A of Part III of the Income Tax Assessment Act 1936.
Division 7A allows a deferral for 2019/2020 LRBA payments until 30 June 2021 but SMSFs need to apply to the ATO for this.
Previously there was some ambiguity around whether under a deferral such loans could capitalise interest and not be penalised. However, the ATO confirmed that would not be the case at the SMSF Association conference in February.
The short answer is a qualified yes.
Section 67A(1)(a)(ii) of the SIS Act, which outlines the conditions under which an LRBA is allowed, also permits an LRBA to be refinanced.
The ATO confirmed this in Interpretive Decision ID 2010/169 stipulating that:
- The money borrowed under the refinancing arrangement needs to be used solely for the purpose of replacing the earlier borrowing
- The new arrangement meets 67A of the SIS Act (if the refinancing occurred on or after 7 July 2010)
- Legal ownership of the asset is not temporarily acquired by the SMSF trustee.
A refinancing of an LRBA cannot be used to increase the borrowing amount, nor can it be used to buy an additional asset.
The ATO also confirmed in Practical Guidance 2016/5 FAQs that LRBAs with related party lenders can be refinanced, explaining:
There is no prohibition on the refinancing of an existing loan with a related party lender. However, to ensure that the NALI provisions do not apply, SMSF trustees will need to provide evidence that the refinanced loan is established and maintained on terms consistent with an arm’s-length dealing; for example, by applying the safe harbour guidelines in PCG 2016/5 if applicable.
Finally, Broderick issued a reminder for all trustees to make and keep proper records for any changes.
“Certainly, in the midst of everything being shut down, there were a lot of people offering very generous deferrals…now the dust has settled a bit it’s very important to go back and make sure that if there was relief offered that it really ties back into one of these ABA or benchmarked or Division 7A because otherwise it really does open up a risk,” he said.
Once the COVID crisis is over and the world returns to something like business as usual in two to three years’ time, that’s when a fund might get an ATO audit.
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