The ATO recently released PCG 2016/5 frequently asked questions, which serves as a handy reminder of the 31 January 2017 deadline.
Following the release of PCG 2016/5 in April 2016, the ATO initially required each SMSF trustee with a non-bank limited recourse borrowing arrangement (‘LRBAs’) to ensure it was on arm’s length terms by 30 June 2016. Following the May 2016 Federal Budget’s announcement of a substantial reduction to the non-concessional contributions cap, this deadline was extended to 31 January 2017.
We have been assisting numerous clients in relation to what needs to be done to satisfy the criteria in PCG 2016/5. We have also received a number of queries from advisers concerned that their SMSF clients may not be able to fully rectify their non-arm’s length LRBAs by 31 January 2017.
This article provides a few tips in relation to the ATO’s PCG 2016/5 FAQs.
Paragraph 16 of PCG 2016/5 provides broadly that LRBAs will not be subject to any further compliance action for FY2015 (or before) if, by 31 January 2017 the LRBA is:
- on terms that are consistent with an arm’s length dealing from 1 July 2015; or
- brought to an end, and payments of principal and interest are made under LRBA terms from 1 July 2015 consistent with an arm’s length dealing.
Many may have missed the finer detail here, ie, even if the LRBA is brought to an end by 31 January 2017, the loan must still be rectified for the period of 1 July 2015 and 31 January 2017. From 1 February 2017 regular monthly repayments of principal and interest must generally be made.
PCG 2016/5 FAQs
PCG 2016/5 FAQs also notes that any restructuring must be carefully documented:
Restructure of the LRBA can occur anytime up to and including 31 January 2017 and the interest rate and other terms (eg loan to market value ratio (LVR) and remaining loan term) should reflect the date the restructure is done. We would consider it best practice for the SMSF to record accrued liabilities for any additional principal and interest payments relating to the 2015–16 year, made after 30 June 2016 and by 31 January 2017, if the fund does not report the relevant income as NALI in the 2016 SMSF annual return.
Broadly, this means that any accrued liabilities from 1 July 2015 will need to be accurately reflected in the SMSF’s FY2016 financial statements and annual return if the SMSF seeks to comply with one of the safe harbours in PCG 2016/5 by 31 January 2017 and has not by 30 June 2016 paid the full amount then owing to the lender. If the SMSF does not comply by 31 January 2017, then all past liabilities under the loan for principal and interest should be reflected in the SMSF’s FY2016 financial statements and annual return according to the ATO.
Where to now?
SMSF trustees with non-bank LRBAs on non-arm’s length terms therefore broadly have the following three options:
- repay the loan to the related party, and bring the LRBA to an end before 31 January 2017. Note that under this option, for any period after 1 July 2015 that the original loan remains in place, the SMSF must ensure that the terms of the loan are consistent with an arm’s length dealing, and the relevant amounts of principal and interest are paid to the lender (including any catch up payments);
- refinance through a commercial or arm’s length lender. Note that under this option, for any period after 1 July 2015 that the original loan remains in place, the SMSF must ensure that the terms of the loan are consistent with an arm’s length dealing, and the relevant amounts of principal and interest are paid to the lender; or
- alter the terms of the loan to terms consistent with an arm’s length dealing. For assets covered by PCG 2016/5 (eg, real estate and listed securities), this could include altering the loan terms to those set out in PCG 2016/5. For assets not covered by PCG 2016/5, eg, units in an unlisted unit trust or shares in a private company, the trustee should have arm’s length benchmark evidence to support the terms of the arrangement. Payments of principal and interest may be required to bring repayments up to date with effect from 1 July 2015 and the loan to value ratio should be in line with the new loan terms.
What happens if you can’t repay?
So what if an SMSF trustee is not able to rectify the loan for the period between 1 July 2015 and 31 January 2017?
The PCG 2016/5 FAQs provides as follows:
If by the 31 January 2017 deadline a taxpayer has not satisfied PCG 2016/5, will the ATO give taxpayers a further opportunity to rectify the loan arrangement?
Where SMSF trustees have not satisfied all the criteria of the PCG 2016/5, it does not mean that the arrangement will necessarily be deemed to be non-arm’s length. This only means that the trustees are unable to be assured that the Commissioner will accept the arrangement to be consistent with an arm’s length dealing.
PCG 2016/5 states that we will not select an SMSF for an income tax review for the 2014–15 year or earlier years purely because the SMSF has entered into an LRBA. However, this is conditional on the trustee ensuring that any LRBA that their fund has is on terms consistent with an arm’s length dealing by 31 January 2017 or, alternatively, is brought to an end by that date. In addition, payments of principal and interest must be made under the LRBA terms consistent with an arm’s length dealing by 31 January 2017.
Following this deadline, if it is considered that the NALI provisions apply to a particular LRBA and no reasonable attempt has been made to bring the arrangement in line with an arm’s length dealing, the NALI provisions will apply from the commencement of the arrangement.
An important take away from the PCG 2016/5 FAQs is that if the LRBA is not rectified by the 31 January 2017 deadline, and the arrangement is not on arm’s length terms, the NALI provisions will apply from the commencement of the arrangement (ie, not just from 1 July 2015). The NALI provisions may result in all income generated from a non-arm’s length arrangement, less certain deductions, being taxed at 47%. The ATO may however be precluded from opening up an SMSF’s income tax assessment beyond a 4 year period, or six years where Part IVA applies, unless fraud or evasion is alleged.
PCG 2016/5 FAQs encourages any SMSF trustee that may have difficulty in meeting the 31 January 2017 deadline to contact the ATO in writing as soon as possible.
Ideally each SMSF trustee can easily prove that each non-bank LRBA is on arm’s length terms. If an SMSF trustee is unable to meet the 31 January 2017 deadline, they should seek legal advice or consider contacting the ATO as soon as possible to discuss their options.
DBA Lawyers can provide advice and excellent services on LRBAs. Our SMSF LRBA documents reflect the latest changes including the recent ATO developments discussed above. Our LRBA documentation services include:
- alteration of related party loan terms;
- SMSF borrowing loan refinance; and
- SMSF borrowing (standard and premium packages available).
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For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.