Taxation Determination TD 2016/16
Date of effect: 28 September 2016

What this ruling is about: This publication (excluding appendixes) is a public ruling for the purposes of the Taxation Administration Act 1953. A public ruling is an expression of the Commissioner's opinion about the way in which a relevant provision applies, or would apply, to entities generally or to a class of entities in relation to a particular scheme or a class of schemes. If you rely on this ruling, the Commissioner must apply the law to you in the way set out in the ruling (unless the Commissioner is satisfied that the ruling is incorrect and disadvantages you, in which case the law may be applied to you in a way that is more favourable for you - provided the Commissioner is not prevented from doing so by a time limit imposed by the law). You will be protected from having to pay any underpaid tax, penalty or interest in respect of the matters covered by this ruling if it turns out that it does not correctly state how the relevant provision applies to you. Ruling 1. When parties to a scheme, that include a trustee of a self-managed superannuation fund (SMSF), have entered into a limited recourse borrowing arrangement (LRBA) on terms which are not at arm's length, it is necessary to consider whether the SMSF has derived more ordinary or statutory income under the scheme than it might have been expected to derive if the parties had been dealing with each other at arm's length in relation to the scheme. [1] Non-arm's length income (NALI) will only arise in those cases where the answer to this question is affirmative. 2. In answering the question above, it is necessary to identify both the steps of the relevant scheme and the parties that deal with each other under those steps of the scheme. Having identified the steps and parties to the scheme, paragraph 295-550(1)(b) of the ITAA 1997 requires a determination of the amount of ordinary or statutory income that the SMSF might have been expected to derive if the same parties to the scheme had been dealing with each other on an arm's length basis under each identified step of the scheme. 3. It is therefore necessary to identify what the terms of the borrowing arrangement may have been if the parties were dealing with each other at arms' length ('the hypothetical borrowing arrangement'). 4. Having identified a hypothetical borrowing arrangement between the SMSF and the lender the terms of which are on an arm's length basis, it is then necessary to establish whether it is reasonable to conclude that the SMSF could have and would have entered into the hypothetical borrowing arrangement. 5. Where it is reasonable to conclude that the SMSF could not have, or would not have entered into the hypothetical borrowing arrangement, the SMSF will have derived more ordinary or statutory income under the scheme than it might have been expected to derive under the scheme with the hypothetical borrowing arrangement. In this instance, the ordinary or statutory income derived under the scheme is NALI. Example: SMSF acquired a commercial real property financed by an LRBA for rental income 6. Relevant facts: 7. The following table outlines the terms of the LRBA under the scheme where the parties were not acting at arm's length (the 'Current LRBA') compared with the terms under the hypothetical borrowing arrangement (for the purposes of this example, the terms adopted are consistent with PCG 2016/5) to acquire the commercial real property: 8. For the hypothetical borrowing arrangement: 9. Based upon the facts above, it is clear that the SMSF could not and would not have entered into the arm's length hypothetical borrowing arrangement. This conclusion is based upon the fact that: 10. Because the SMSF could not have and would not have acquired the commercial real property under the hypothetical borrowing arrangement, the income that the SMSF would be expected to derive from the scheme if the parties were dealing with each other at arm's length is nil. If the parties were dealing with each other at arm's length in relation to the scheme the investment in the commercial real property would not occur, as no arm's length LRBA could have been entered into. 11. Therefore, the $1,000 per week rental income the SMSF receives is NALI. [3] Date of effect 12. This Determination applies to income years commencing both before and after its date of issue. However, this Determination will not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of this Determination (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10). Commissioner of Taxation 28 September 2016




Appendix: 13. When an SMSF acquires an asset under a LRBA, subsection 295-550(1) of the 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. 14. Subsection 295-550(1) of the ITAA 1997 provides that an amount of ordinary or statutory income is NALI of a complying superannuation fund, a complying approved deposit fund or certain pooled superannuation trusts if: 15. If it is established that the parties are not dealing with each other at arm's length because the terms of an LRBA are not consistent with an arm's length dealing, then paragraph 295-550(1)(a) of the ITAA 1997 is satisfied. [4] It is not required that all parties to the scheme be acting on a non-arm's length basis. Rather, where some of the parties are not acting at arm's length in respect of any step in the scheme, paragraph 295-550(1)(a) is satisfied. 16. To satisfy paragraph 295-550(1)(b) of the ITAA 1997, it is necessary to identify both the steps of the relevant scheme and the parties that deal with each other under those steps of the scheme. Having identified the steps and parties to the scheme, paragraph 295-550(1)(b) requires a determination of the amount of ordinary or statutory income that the SMSF might have been expected to derive if the same parties to the scheme had been dealing with each other on an arm's length basis under each identified step of the scheme. 17. Accordingly, it is necessary to identify what the terms of the borrowing arrangement would have been if those same parties had been acting on an arm's length basis under a hypothetical borrowing arrangement in respect of the same steps of the scheme, without introducing any new steps or parties to the scheme. The terms of the borrowing arrangement to be considered include (but are not limited to): 18. Once the terms of the hypothetical borrowing arrangement are identified [5] , consideration is then required as to whether or not it is objectively reasonable to expect that the SMSF trustee could have and would have entered into the hypothetical borrowing arrangement. 19. The following factors are relevant in considering whether an SMSF trustee 'could have' acquired the asset under the relevant hypothetical borrowing arrangement: 20. The following factors are relevant in considering whether the SMSF trustee 'would have' entered into the hypothetical borrowing arrangement: 21. Where it is reasonable to conclude that the SMSF could not have, or would not have entered into the hypothetical borrowing arrangement, the SMSF will necessarily have derived more ordinary or statutory income from the non-arm's length scheme than it might have been expected to derive from the scheme with the hypothetical borrowing arrangement. That income will therefore be NALI. 22. Where the SMSF can objectively establish with evidence that it could have and would have entered into the hypothetical borrowing arrangement, a comparison can then be made of the SMSF's ordinary or statutory income from the scheme (where the parties have not been dealing with each other at arm's length and have entered into an LRBA on terms which are not at arm's length) and the income under the hypothetical borrowing arrangement. © AUSTRALIAN TAXATION OFFICE FOR THE COMMONWEALTH OF AUSTRALIA You are free to copy, adapt, modify, transmit and distribute this material as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products). Not previously issued as a draft


Amount sourced from fund capital | Variable, 5.75% p.a. for the 2015-2016 year [2] | Loan to Market Value ratio (LVR) | Mortgage in favour of the Lenders is registered in respect of the asset | No personal guarantees or other security are given to the lenders in relation to repayment of the loan | Nature and frequency of repayments | No repayment is required until the end of the term of the loan - $0 monthly repayments | Monthly repayments of both principal and interest - approximately $5,800 per month at 5.75% p.a. for the 2015-16 year


Related rulings: TR 2006/10
Legislative references: ITAA 1997 ITAA 1997 295-550(1) ITAA 1997 295-550(1)(a) ITAA 1997 295-550(1)(b) SISA SISA 52B
Other references: PCG 2016/5