Private ruling: Limited recourse borrowing arrangements
Published: March 2014
Ruling period: Income year ending 30 June 2014
Date scheme commenced: During the income year ending 30 June 2014

Ruling: Q1: Does a superannuation fund (the Fund) breach section 109 of the Superannuation Industry (Supervision) Act 1993 (SISA) by entering into a limited recourse borrowing arrangement (LRBA) with related parties of the Fund if a zero rate of interest is charged by the lenders over the term of the borrowing? | A1: A private ruling cannot be given on this question | Q2: Is the interest-free related party borrowing a contribution for the purposes of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No | Q3: Will the interest-free related party borrowing result in any amount being taxed as non-arm's length income of the fund for the purposes of section 295-550 of the ITAA 1997? | A3: Yes

Relevant facts and circumstances: 1. The Fund is a complying self-managed superannuation fund. 2. The trustee of the Fund (the Fund Trustee) is a private company (Private Company 1). 3. Member A and Member B (the Members) are the only members of the Fund and the directors and shareholders of the Fund Trustee. 4. The Fund Trustee, on behalf of the Fund, intends to acquire certain shares (the Shares) through the Australian Stock Exchange. 5. The purchase of the Shares will be funded through a LRBA entered into with the Members in their personal capacity. Recourse by the lenders will be limited to the Shares acquired with funds borrowed under the loan. 6. The terms of the draft Deed of Loan provide that: • The borrower must repay the loan in full, together with all interest thereon, by the Repayment Date; • The repayment date is more than five years after the date of the first drawdown; • Interest rate is fixed 0% per annum. 7. The Shares will be held on trust for the benefit of the Fund. 8. The trustee of the holding trust (the Holding Trustee) is a private company. 9. Directors and shareholders of the Holding Trustee are the Members. 10. The draft Holding Trust Deed provides that the Holding Trustee: • holds the Shares on trust for the Fund Trustee; • will deal with the shares and any proceeds received from dealing and any rights or privileges derived from the shares in accordance with directions and instructions given to the Holding Trustee by the Fund Trustee; and • will act on and comply with any request, direction or instruction received from the Fund Trustee.

Relevant legislative provisions: Taxation Administration Act 1953 Division 359 of Schedule 1 | Taxation Administration Act 1953 Section 357-55 of Schedule 1 | Income Tax Assessment Act 1997 Section 295-550 | Income Tax Assessment Act 1997 Subsection 295-550(4) | Income Tax Assessment Act 1997 Subsection 295-550(5) | Income Tax Assessment Act 1997 Subsection 995-1(1) | Income Tax Assessment Act 1936 Former section 273 | Income Tax Assessment Act 1936 Former subsections 273(6) | Income Tax Assessment Act 1936 Former subsection 273(7) | Superannuation Industry (Supervision) Act 1993 Subsection 10(1) | Superannuation Industry (Supervision) Act 1993 Section 109 | Superannuation Industry (Supervision) Act 1993 Subsection 109(1) | Superannuation Industry (Supervision) Act 1993 Subsection 109(1A) | Superannuation Industry (Supervision) Act 1993 Paragraph 109(1)(b)

Reasons for decision: Summary: 11. Section 109 of the SISA is not a relevant provision for the purposes of making a private ruling. 12. The interest-free related party borrowing is not a contribution for the purposes of the ITAA 1997. 13. The income derived by the Fund through the Holding Trust will be non-arm's length income of the Fund for the purposes of section 295-550 of the ITAA 1997. | Detailed Reasoning - Application of section 109 of the SISA: 14. A private ruling is a written expression of the Commissioner's opinion about the way in which a relevant provision applies or would apply to a taxpayer. 15. Provisions that are relevant to rulings are defined in section 357-55 of Schedule 1 to the Taxation Administration Act 1953 (TAA). Relevant provisions are provisions of Acts and regulations administered by the Commissioner and include the following: • income tax • Medicare levy • fringe benefits tax • withholding taxes (including non-resident withholding taxes and mining withholding tax) • the administration or collection of those taxes, levies and duties. 16. The Commissioner cannot rule on superannuation law relating to the borrowings by a superannuation fund. Such matters are outside the scope of the relevant provisions on which the Commissioner can provide a private ruling. 17. While not a private ruling for the purposes of Division 359 of Schedule 1 to the TAA, we provide the following advice with regard to the application of section 109 of the SISA to the LRBA. 18. When entering into a LRBA, the trustee of a superannuation fund is entering into a contract for the purpose of gaining an interest in the property which is subject of the LRBA, together with any income, profit or capital gain in respect of that property. That is, in accordance with subsection 10(1) of the SISA, the trustee is making an investment. 19. Subsection 109(1) of the SISA imposes requirements with respect to investments made by a trustee of a superannuation fund. It provides that the trustee (or investment manager) must not invest in that capacity unless the trustee and the other party to the relevant transaction are dealing with each other at arm's length in respect of the transaction, or: (b) both: (i) the trustee or investment manager, as the case may be, and the other party to the relevant transaction are not dealing with each other at arm's length in respect of the transaction; and (ii) the terms and conditions of the transaction are no more favourable to the other party than those which it is reasonable to expect would apply if the trustee or investment manager, as the case may be, were dealing with the other party at arm's length in the same circumstances. 20. Similarly subsection 109(1A) of the SISA states that if: (a) a trustee or investment manager of a superannuation entity invests in that capacity; and (b) at any time during the term of the investment the trustee or investment manager is required to deal in respect of the investment with another party that is not at arm's length with the trustee or investment manager; the trustee or investment manager must deal with the other party in the same manner as if the other party were at arm's length with the trustee or investment manager. 21. Subsection 109(1A) of the SISA applies after an investment to which paragraph 109(1)(b) of the SISA applies has commenced and is interpreted in that context. As a result provided the dealing is not more favourable to the other party than would be expected had the parties been at arm's length then the section 109 of the SISA will not be contravened. 22. In this case, the fact that LRBA is interest-free is more favourable to the Fund rather than the Members. Therefore, based on the above, the fact that the LRBA is on interest-free terms does not cause a contravention of section 109 of the SISA as that fact does not make the terms and conditions of the borrowing more favourable to the related party than would be reasonably expected if the parties were dealing with each other at arm's length in the same circumstances. | Detailed Reasoning - Meaning of 'contribution': 23. The term ' contribution ' is not defined in the ITAA 1997. Therefore, consistent with basic principles of statutory interpretation, the term 'contribution' is to be given its ordinary meaning having regard to the context and underlying purpose of the legislative provisions in which the term appears. 24. The Commissioner's view on the meaning of 'contribution' in the superannuation context is set out in Taxation Ruling TR 2010/1. Paragraph 4 of TR 2010/1 states: In the superannuation context, a contribution is anything of value that increases the capital of a superannuation fund provided by a person whose purpose is to benefit one or more particular members of the fund or all of the members in general. 25. Where an arrangement is put in place to ensure that a superannuation fund does not incur a liability to meet certain expenses, as illustrated by the examples in paragraphs 75, 76, 81 and 82 of TR 2010/1, there is no increase in the capital of the superannuation fund because no forgiveness or extinguishment of any liability is involved. Consequently, no superannuation contribution is made to the superannuation fund under the arrangement. 26. Similarly, where, under the terms of a loan, no interest is charged on the borrowings of a superannuation fund, no liability to pay interest is incurred. As there is no liability to pay interest in the first instance, there can be no forgiveness or extinguishment of any such liability. As such, the absence of a requirement to pay interest on borrowings does not increase the capital of the superannuation fund. 27. Based on the above, it is considered that the provision of a limited recourse borrowing on interest-free terms to the Fund by the members of the Fund is not a contribution for the purposes of the ITAA 1997. | Detailed Reasoning - Meaning of 'non-arm's length income': 28. The phrase 'non-arm's length income' has the meaning given by section 295-550 of the ITAA 1997. 29. In accordance with subsection 295-550(4) of the ITAA 1997, income derived by the entity as a beneficiary of a trust, other than because of holding a fixed entitlement to the income, is non-arm's length income of the entity. 30. Subsection 295-550(5) provides that: Other income derived by the entity as a beneficiary of a trust through holding a fixed entitlement to the income of the trust is non-arm's length income of the entity if: (a) the entity acquired the entitlement under a scheme, or the income was derived under a scheme, the parties to which were not dealing with each other at arm's length; and (b) the amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm's length. 31. Taxation Ruling TR 2006/7 explains what amounts are considered to be 'special income' under section 273 of the Income Tax Assessment Act 1936 (ITAA 1936) which was repealed with effect from 1 July 2007. Former section 273 has been re-written, with some modifications in section 295-550 of the ITAA 1997. To the extent that section 295-550 of the ITAA 1997 expresses the same ideas as section 273, TR 2006/7 is also taken to be a ruling about section 295-550 of the ITAA 1997. 32. In accordance with paragraph 101 of TR 2006/7, if a complying superannuation fund derives income from a trust by way of the trustee or any other person exercising a discretion, the income distributed will be non-arm's length income under subsection 295-550(4) of the ITAA 1997. 33. A trust distribution to a complying superannuation fund will fall within subsection 295-550(5) of the ITAA 1997 rather than subsection 295-550(4) of the ITAA 1997 only if the fund's entitlement to the distribution does not depend upon the exercise of the trustee's or any other person's discretion, that is, if the fund holds a fixed entitlement to the income of the trust (paragraph 102 of TR 2006/7) 34. In all cases, the determining factor in deciding if a fixed entitlement exists is the terms of the trust instrument under which the trust is constituted. 35. After considering the terms of the Holding Trust Deed it is our view that the Fund does not hold a fixed entitlement to the income of the Holding Trust arising in respect of the Shares. This view is based on fact that the Holding Trustee is required to deal with the Shares (and any proceeds, rights and privileges derived from the Shares) in accordance with the instructions and directions given to the Holding Trustee by the Fund Trustee. Namely, the entitlement to a distribution from the Holding Trust depends on the exercise of the Fund Trustee's discretion. 36. Therefore, any income derived by the Fund from the Holding Trust will be non-arm's length income of the Fund in accordance with subsection 295-550(4) of the ITAA 1997.