PCG 2016/5: Income tax - arm's length terms for Limited Recourse Borrowing Arrangements established by self-managed superannuation funds
Document type: Final PCG
Status: Current
Date of issue: 28 September 2016

1. When a self-managed superannuation fund (SMSF) acquires an asset under a Limited Recourse Borrowing Arrangement (LRBA), the non-arm's length income (NALI) provisions in section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997) may apply to ordinary or statutory income generated from the asset if the terms of the LRBA are not consistent with an arm's length dealing. 2. This Guideline sets out the 'Safe Harbour' terms on which SMSF trustees may structure their LRBAs consistent with an arm's length dealing. That is, for income tax compliance purposes, the Commissioner accepts that an LRBA structured in accordance with this Guideline is consistent with an arm's length dealing and that the NALI provisions do not apply purely because of the terms of the borrowing arrangement. 3. As noted at paragraph 5 of this Guideline, this Guideline applies where the requirements of section 67A (or former subsection 67(4A) if applicable) of the Superannuation Industry (Supervision) Act 1993 (SISA) are met at all times and is not intended to override or replace those or any other SISA requirements that apply. 4. If SMSF trustees have entered into an arrangement which does not meet all of the 'Safe Harbour' terms set out in this Guideline, while the trustees are unable to be assured that the Commissioner will accept the arrangement to be consistent with an arm's length dealing, it does not mean that the arrangement is deemed not to be on arm's length terms. It merely means that there is no certainty provided under this Guideline. The trustees will need to be able to otherwise demonstrate that the arrangement was entered into and maintained on terms consistent with an arm's length dealing. One example of how a trustee may demonstrate this is by maintaining evidence that shows their particular arrangement is established and maintained on terms that replicate the terms of a commercial loan that is available in the same circumstances.


11. ATO Interpretative Decisions ATO ID 2015/27 Income tax: non-arm's length income - related party non-commercial limited recourse borrowing arrangement to acquire listed shares and ATO ID 2015/28 Income tax: non-arm's length income - related party non-commercial limited recourse borrowing arrangement to acquire real property, have been withdrawn. The Commissioner issued TD 2016/16 on 28 September 2016. 12. Parties, including an SMSF, who enter into an LRBA on terms not consistent with an arm's length dealing should consider the further matters addressed in TD 2016/16. 13. If we are asked to state formally (for example, in a private ruling or in litigation) whether a particular SMSF's LRBA gives rise to NALI for any income year, our approach will be consistent with TD 2016/16.

Intro: 14. The ATO recognises the effects of the NALI provisions and the importance of preserving assets held by an SMSF. Given this, 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 SMSF 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 31 January 2017. 15. In addition, payments of principal and interest must be made under LRBA terms consistent with an arm's length dealing. SMSF trustees who are concerned about their ability to make the required payments on commercial terms before 31 January 2017 can contact the ATO to discuss their particular circumstances. In the first instance, taxpayers can write to us, outlining their particular circumstances, at the following address: 16. In other words, SMSF trustees have an opportunity to review the terms of their funds' LRBAs before 31 January 2017. The terms of their LRBAs will not be subject to any further compliance action for the 2014-15 income years (or before) if, by 31 January 2017: 17. Furthermore, SMSF trustees who satisfy these conditions, and apply this Guideline in good faith to revise the terms of their existing LRBAs before 31 January 2017, can be assured that the terms of their LRBA will not be subject to any further compliance action by the ATO for the 2014-15 years and prior. 17A. An SMSF trustee who satisfies the condition set out in paragraph 16(i) of this Guideline with respect to an LRBA can also be assured that the Commissioner will not apply compliance resources to determine whether paragraphs 295-550(1)(b) or (c), or paragraphs 295-550(5)(b) or (c), of the ITAA 1997 apply to income derived by the SMSF for the 2018-19 and later income years from an asset that is subject to that LRBA. 18. The following examples illustrate how the Safe Harbours apply in conjunction with the opportunity for SMSF trustees to review and revise the terms of their LRBAs before 31 January 2017.

Example 1: real property 19. A complying SMSF borrowed money under an LRBA on terms consistent with section 67A of the SISA. It used the funds to acquire commercial property valued at $500,000 on 1 July 2011. 20. The loan has the following features: 21. We do not consider that this LRBA has been established or maintained on arm's length terms. The income earned from the property, which is rented to an unrelated party, may give rise to NALI. 22. As at 1 July 2015, the property was valued at $643,000. 23. The SMSF has not repaid any of the principal since the loan commenced. 24. If, after considering TD 2016/16, it is determined that the income earned from the property is in fact NALI, to avoid having to report NALI for the current year (and prior years) the Fund has a number of options. Option 1 - Alter the terms of the loan to meet guidelines 25. The SMSF and the lender could alter the terms of the loan arrangement to meet Safe Harbour 1 for real property (see paragraph 6 of this guideline). 26. To bring the terms of the loan into line with Safe Harbour 1, the trustees of the SMSF must ensure that: Option 2 - Refinance through a commercial lender 27. The fund could refinance the LRBA with a commercial lender, extinguish the original arrangement and pay the associated costs. 28. 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 relevant amounts of principal and interest are paid to the original lender. 29. The SMSF may choose to apply the terms set out under Safe Harbour 1 to calculate the amounts of principal and interest to be paid to the original lender for the relevant period. Option 3 - Pay out the LRBA 30. The SMSF may decide to repay the loan to the related party and bring the LRBA to an end before 31 January 2017. 31. 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 original lender. 32. The SMSF may choose to apply the terms set out under Safe Harbour 1 to calculate the amounts of principal and interest to be paid to the original lender for the relevant period. | Example 2: collection of listed shares 33. A complying SMSF borrowed money under an LRBA on terms consistent with section 67A of the SISA. It used the funds to acquire a collection of stock exchange-listed shares valued at $100,000 on 1 July 2011. 34. The loan has the following features: 35. We do not consider that this LRBA has been established or maintained on arm's length terms. The dividend income earned from these shares may give rise to NALI. 36. As at 1 July 2015, the parcel of shares was valued at $120,000. 37. The SMSF has not repaid any of the principal since the loan commenced. 38. If, after considering TD 2016/16, it is determined that the dividend income is in fact NALI, to avoid having to report NALI for the current year (and prior years) the SMSF has a number of options. Option 1 - Alter the terms of the loan to meet guidelines 39. The SMSF and the related party could alter the terms of the loan to comply with Safe Harbour 2 for a collection of stock exchange listed shares (see paragraph 8 of this guideline). 40. To bring the terms of the loan into line with Safe Harbour 2, the trustees of the SMSF must ensure that: Option 2 - Refinance through a commercial lender 41. The SMSF could refinance the LRBA with a commercial lender, extinguish the original arrangement and pay the associated costs. 42. 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 that principal and interest amounts are paid to the original lender. 43. The SMSF may choose to apply the terms set out in Safe Harbour 2 to calculate the amounts of principal and interest to be paid to the original lender for the relevant period. Option 3 - Pay-out the LRBA 44. The SMSF may decide to repay the loan to the related party and bring the LRBA to an end before 31 January 2017. 45. 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 for that period are paid to the original lender. 46. The SMSF may choose to apply the terms set out in Safe Harbour 2 to calculate the amounts of principal and interest to be paid to the original lender for the relevant period.



What this Guideline is about | Safe Harbour 1: The asset acquired is real property | Safe Harbour 2: The asset acquired is a collection of stock exchange-listed shares or units | Background and additional information | ATO's compliance approach for LRBAs established before 30 June 2016 | This Practical Compliance Guideline sets out a practical administration approach to assist taxpayers in complying with relevant tax laws. Provided you follow this guideline in good faith, the Commissioner will administer the law in accordance with this approach. | Date of effect: 5. This Guideline applies to SMSF trustees who have established LRBAs that meet the requirements of section 67A (or former subsection 67(4A) if applicable) of the SISA, regardless of whether the arrangement commenced before or after the date of publication of this Guideline. | Safe Harbour 1: The asset acquired is real property: 6. Safe Harbour 1 applies when an SMSF uses an LRBA to acquire real property or to refinance a borrowing used to acquire real property, whether that property is residential or commercial premises (including property used for primary production activities). | 7. The ATO accepts that an LRBA used to acquire real property, or to refinance a borrowing used to acquire real property, is consistent with an arm's length dealing if the terms of the borrowing are established and maintained throughout the LRBA as set out in the following table. | The fixed rate is the rate published for May (the rate for the May before the relevant financial year). | The 2015-16 rate of 5.75% may be used for LRBAs in existence on publication of these guidelines, if the total period for which the interest rate is fixed does not exceed five years (see 'Term of the loan' below) | Variable interest rate loan (re-financing) - maximum loan term is 15 years less the duration(s) of any previous loan(s) relating to the asset (for both residential and commercial). | Fixed interest rate loan - a new LRBA commencing after publication of these guidelines may involve a loan with a fixed interest rate set at the beginning of the arrangement. The rate may be fixed for a maximum period of five years and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 15 years. | For an LRBA in existence on publication of these guidelines, the trustees may adopt the rate of 5.75% as their fixed rate, provided that the total fixed-rate period does not exceed five years. The interest rate must convert to a variable interest rate loan at the end of the nominated period. The total loan cannot exceed 15 years. | Loan to Market Value Ratio (LVR) | If more than one loan is taken out to acquire (or refinance) the asset, the total amount of all those loans must not exceed 70% LVR. | The market value of the asset is to be established when the loan (original or re-financing) is entered into. | For an LRBA in existence on publication of these guidelines, the trustees may use the market value of the asset at 1 July 2015. | A registered mortgage over the property is required. | Nature & frequency of repayments | A written and executed loan agreement is required. | Safe Harbour 2: The asset acquired is a collection of stock exchange-listed shares or units: 8. Safe Harbour 2 applies when an SMSF uses an LRBA to acquire a collection of shares in a stock exchange-listed company or to acquire units in a stock exchange-listed unit trust. Safe Harbour 2 also applies when an SMSF uses an LRBA to refinance a borrowing used to acquire such a collection. | 9. The ATO accepts that an LRBA used to acquire or to refinance a borrowing used to acquire stock exchange-listed shares or stock exchange-listed units in a unit trust is consistent with an arm's length dealing if the terms of the borrowing are established and maintained throughout the LRBA, as set out in the following table. | The 2015-16 rate of 7.75% may be used for LRBAs in existence on publication of these guidelines, if the total period for which the interest rate is fixed does not exceed three years (see 'Term of the loan' below) | Variable interest rate loan (re-financing) - maximum loan term is seven years less the duration(s) of any previous loan(s) relating to the collection of assets. | Fixed interest rate loan - a new LRBA commencing after publication of these guidelines may involve a loan that has a fixed interest rate set at the beginning of the arrangement. The rate may be fixed up to for a maximum of three years and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed seven years. | If more than one loan is taken out to acquire (or refinance) the collection of assets, the total amount of all those loans must not exceed 50% LVR. | The market value of the collection of assets is to be established when the loan (original or re-financing) is entered into. | A registered charge/mortgage or similar security (that provides security for loans for such assets). | More information: 10. For more information see: | PO Box 3100 Penrith NSW 2740 | Commissioner of Taxation 28 September 2016 | Paragraph inserted to reflect an extension (to later income years) of the Commissioner's compliance approach to the application of the NALI provisions to LRBAs entered into prior to the 2014-15 income year and that were made consistent with an arm's length dealing by 31 January 2017. | Minor updates made throughout to align with current ATO style. | Insertion of reference to TD 2016/6. Deletion of references to ATO ID 2015/27 and ATO ID 2015/28. | Changes made to reflect publication of TD 2016/6 as replacement for withdrawn ATO IDs 2015/27 and 2015/28. | References to 30 June 2016 changed to 31 January 2017. | Changes made to reflect change of date for review and revision of terms of LRBAs from 30 June 2016 to 31 January 2017. | Related Rulings/Determinations: SMSFR 2012/1 TD 2016/16

Related rulings and determinations: TD 2016/16 | TD 2016/6
Legislative references: ITAA 1997 ITAA 1997 295-550 ITAA 1997 295-550(1) SISA 1993 SISA 1993 67A SISA 1993 67(4A) SISA 1993 67B
Other references: ATO ID 2015/27 (Withdrawn) ATO ID 2015/28 (Withdrawn) SPR 2014/1