SMSFs digest clarification of lending rules
Are changes to SMSFs rules making you reconsider your existing lending agreements?
Changes to the rules around how self-managed super funds (SMSFs) can borrow from related parties mean many self-managed super fund trustees must now reconsider whether their existing lending arrangements comply with the newly articulated requirements.
While the changes will mean some funds will have to pay more in interest, the upside is they now have clarity from the Australian Taxation Office (ATO) around lending arrangements with related parties.
“In recent years it has become common for SMSFs to borrow in order to buy assets, most commonly property. Usually the lender will be a bank, although in some cases it will be a related party such as the members themselves,” explains Greg Einfeld, a director of SMSF specialist business Lime Super.
“The ATO recently issued Safe Harbour Guidelines for Self Managed Super Funds that have borrowed from a related party. These guidelines set out the terms that are considered to be commercial, or arms’ length,” he says.
The ATO had previously implied that when a related party lends money to an SMSF, there was no requirement for a commercial, that is, market interest rate.
The tax office is understood to have introduced these changes to ensure SMSF members are not given an unfair advantage compared to other investors. A related party can be a member of the fund, or a relative or associate of one of the fund’s members or trustees.
“In 2015, for the first time, the ATO indicated that related party loans should be on commercial terms. The challenge for the SMSF industry was that the ATO had not defined commercial terms, so trustees of SMSFs had no guidance as to what was considered commercial,” says Einfeld.
He notes that these terms are broader than just the interest rate. They also include the loan to value ratio (LVR), term, security, and whether the loan requires principal repayments.
For example, a loan secured by property with a 15 year term, monthly principal and interest repayments, an LVR of 70 per cent, and an interest rate of 5.75 per cent a year would satisfy the guidelines.
The tax office will be looking for SMSFs to be able to prove any lending arrangements meet the terms of the clarified rules, which means the terms of any lending arrangements must be clearly documented.
“The ATO’s guidelines have removed the uncertainty for trustees. Any SMSF loan that complies with the guidelines is considered to be on commercial terms,” says Einfeld.
SMSFs with existing related party loans have until 30 June 2016 to update their loan agreements so that the terms of their loans can be in line with the guidelines.
Alternatively, those SMSFs with existing related party loans could refinance their debt with a bank, or repay their existing debt.
“The time frame is reasonably tight, so trustees with existing related party loans are encouraged to start working on this as soon as possible,” says Einfeld.
“Trustees who are considering buying a property with a related party loan in future should ensure that the terms of their loan conforms with the safe harbour guidelines,” he advises.