SESSION 2B LRBAs and issues with related party Loans. Daniel Butler, CTA DBA Lawyers

Transcription

1 SESSION 2B LRBAs and issues with related party Loans Daniel Butler, CTA DBA Lawyers

2 Overview 1. Background 2. Practical compliance guidelines (PCG ) 2016/5 3. Real property ( RP ) 4. Listed shares or units 5. What if not in safe harbours? 6. Structure of the future? 7. Conclusions

3 BACKGROUND

4 Background In December 2012 NTLG minutes, ATO stated: The ATO position on low rate loan arrangements and LRBA is that they do not generally invoke a contravention of the SISA, do not give rise to nonarm s length income [ NALI ] under s of the ITAA 1997, do not invoke Part IVA of the ITAA 1936 and are not considered to give rise to contributions to the SMSF just from that one fact alone Some SMSFs engaged in related party LRBAs with favourable terms, eg, nil interest rate and/or 100% LVRs Several positive private binding rulings ( PBR ) issued on NALI By 2014 ATO released numerous PBRs confirming NALI ATO ID 2014/39 and 2014/40 in December 2014 confirming NALI Div 235 ITAA 1997 commenced in September 2015 with effect from FY These IDs were replaced with 2015/27 and 2015/28 (in November 2015)

5 Background ATO ID 2014/39 ATO ID 2015/27 ATO ID 2014/40 ATO ID 2015/28 Interest rate? 0% Suggests NAL dealings 0% Suggests NAL dealings Personal guarantees? No Suggests NAL dealings No (Didn't comment is it fine?) Mortgage granted Yes (Didn't comment presumably fine) Yes (Didn't comment presumably fine) Asset being acquired Listed securities (Didn't comment presumably fine) Commercial property (Didn't comment presumably fine) Amount borrowed several million dollars (Didn't comment presumably fine) $500,000 (Didn't comment presumably fine) Length of loan 20 years (Didn't comment presumably fine) 15 years (Didn't comment presumably fine) Type of loan? No payments til end Suggests NAL dealings P&I months (Didn't comment presumably fine) LVR 100% Suggests NAL dealings 80% Suggests NAL dealings

6 Background In December 2015, ATO stated: What you should do by 30 June 2016 SMSF trustees should review any LRBA you have to determine whether it was established and maintained on terms that are consistent with an arm s length dealing Leaves big question: what terms are consistent with an arm s length dealing? What we will do we will not be selecting an SMSF for review for the year or earlier years purely because the fund has entered into an LRBA The Commissioner may allocate compliance resources to review an LRBA of an SMSF for the year or later years We strongly encourage all SMSF trustees to take the actions suggested above in relation to your existing LRBAs before 30 June 2016

7 PCG 2016/5

8 PCG Industry requested extra guidance from ATO ATO released PCG 2016/5 on 6 April 2016 If you fall within the PCG terms, the ATO accepts NALI does not apply purely because of the terms of the borrowing arrangement NALI can still, however, arise: SMSF acquires an asset below market value SMSF leases business RP to related party at above market rent So what are the safe harbour terms?

9 PCG

10 PCG Interest rates based on: RBA Indicator Lending Rate for standard variable housing loans for investors Variable rate set based on the rate in May for the next FY, eg: for FY2016 a 5.75% rate for FY2017 refer to May % rate Fixed rate loans have a max term and can then convert to a variable rate loan 30 May 2016, ATO extended the 30 June 2016 deadline to 31 January

11 PCG LVR relies on market value: when the loan (original or re-financing) is entered into existing LRBAs, the asset value as at 1 July 2015 Example with property (extracted from PCG and revised): SMSF with $500k LRBA for 25 yr term (commenced 1 July 2011) Property valued at $643k on 1 July 2015 Option 1 alter loan terms Reduce loan to $450k to obtain a 70% LVR The loan term reduces to 11 yrs (4 yrs already) Principal and interest payments by 31 January 2017 (calculated with effect from 1 July 2015) Monthly principal and interest payments from 1 February 2017

12 PCG Example with property (Cont): Option 2 Refinance through a commercial lender Make sure payments of principal and interest are made before February 2017 The new lender pays out the old lender Option 3 Pay out the LRBA Make sure payments of principal and interest are made before February 2017 Terminate the LRBA before February 2017 What if there is a refinance on 30 January 2017 and the market value of the asset has increased to $800k? What impact does this have on the LVR? LVR decreases from 70% (450/643) to 56.25% (450/800)

13 PROPERTY

14 Property Is 5.65% higher than what an SMSF could borrow from a bank? What property does this apply to? Presumably all RP at [6]: RP, whether that property is residential or commercial premises (including property used for primary production activities) Will a bank lend to an SMSF at a 70% LVR to acquire a farm? Will a bank lend to an SMSF at a 70% LVR to acquire a 50% tenants in common ( T-i-C ) interest in a farm? PCG does not discuss T-i-C interests Banks are unlikely to lend on a T-i-C interest Yes: this makes PCG sound conservative No: this makes PCG sound aggressive However, recall opening words of PCG Provided you follow this guideline in good faith

15 Property ATO are ok with T-i-C; it s an interest in RP Is company title RP (where RP owned via shares in a company)? ATO are not ok as this is not an interest in RP: any LRBA would need to be established on arms length terms Life interests are also becoming more popular? ATO have a number of concerns about life interest strategies A life interest may constitute an interest in RP Hwr, what about an ACT leasehold interest?

16 LISTED SHARES OR UNITS

17 Listed shares or units Max 7 year loan/3 year fixed/50% LVR and + 2% interest rate A collection of shares in a stock exchange listed company or to acquire units in a stock exchange listed unit trust Collections of shares and units must be acquired and disposed of as a bunch/tranche for LRBAs post-7 July 2010 There is no margin lending type LRBA facility post-july 2010 Check whether listed, what about: Shares in a US listed company (eg, Apple)? Yes Shares in less known Australian stock exchange (eg, the NSX)? Yes Options listed on the ASX? No Units in a managed fund that is widely held and very transparent but not listed (eg, certain Vanguard units)? No

18 Listed shares or units

19 PRIVATE SHARES OR UNITS

20 Private shares and units If the asset involves: private company shares; or units in an unlisted unit trust, benchmark arm s length evidence needed (no safe harbour) Evidence may come from a mortgage broker, P2P lender and other sources, eg, private lenders Also, obtaining a mortgage or equivalent security over the asset is important and: if the asset is real estate, a mortgage is obtained if the asset is personal property, a security interest under the Personal Property Securities Act 2014 (Cth) is obtained

21 PCG

22 PCG PCG is linked to RBA Indicator Lending Rates for banks providing standard variable housing loans for investors FY % FY % Interest rate benchmark FY2016 is it nominal or effective? 5.75% nominal rate 5.90% effective rate ATO effective given monthly payments/compounding PCG is not clear on refinancing with a related party, eg, para 26 states: The fund could refinance the LRBA with a commercial lender, extinguish the original arrangement and pay the associated costs

23 PCG However, other references to refinancing in the PCG do not suggest a commercial lender must be involved: PCG para s 4 & 7 refer to commercial in the context of an arm s length lender or a loan on arm s length terms (cf: a commercial lender) ATO have confirmed that there is no need for an arm s length lender and a refinance can occur with a related party PCG states: 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 If one loan is from bank and the other from a related party deed of priority gives a bank 1st bite of the cherry

24 PCG ATO view: in instances where more than one loan is used to acquire or refinance real property then both loans should be secured by a registered mortgage Treasurer has confirmed concessions to the $500k lifetime cap: SMSFs with existing borrowings members can make further NCCs to satisfy legal obligations pre-budget, eg: to comply with PCG on related party LRBAs to pay down borrowings? Grandfathering to 31 January 2017 (unless ATO extends deadline) Example: SMSF buys property with $500k LRBA for 25 yr term (1 July 2011)

25 PCG Member seeks to contribute: Principal and interest from 1 July 2015 to 31 January 2017 prior to 31 January 2017 ( Accrued Amount ) Treasurer s letter suggests a contribution of the Accrued Amount does not use up the member s lifetime cap What if, instead, the member seeks to contribute: the Accrued Amount plus any balance to pay out the LRBA before 31 Jan 2017? Treasurer s letter suggests this would not use up the member s lifetime cap Legislation to confirm Treasurer s relief prudent to await clarification

26 PLANNING

27 Planning The $500k lifetime cap may encourage more SMSFs to borrow LRBAs that comply with PCG safe harbour If you satisfy a safe harbour, do you satisfy div 7A? Probably yes, eg, for FY2017 : PCG 5.65% Div 7A 5.4% However, it s worth monitoring rates in the future Div 7A could also be varied as the Taxation Board of Review has recommended changes to div 7A. The 2016 Budget also confirmed div 7A would be changed: An interest rate based on small business overdraft rate A max 10 year term

28 Planning Will the following become a popular structure? Family trust running business $$$$$ **Distribution** Less tax at corporate tax rate **PCG compliant (and hopefully div 7A compliant) loan** SMSF Corporate beneficiary

29 Planning ATO will review related party LRBAs What is the ATO on the lookout for? Some current examples that the ATO is concerned about include: dividend stripping non-arm s length (LRBAs) personal services income check-it-out!/ TA 2012/7 ATO say that an LRBA is an exception to a prohibited activity, ie, borrowing. Thus SMSFs must satisfy the criteria in ss 67A and 67B ATO will apply NALI unless covered by PCG or arm s length evidence SMSFs have been rendered non-complying for contravening LRBA rules

30 Planning AFSL risks: an investment in real estate is not a financial product ( FP ). However, ASIC s report 337 states: A person provides a financial service (i.e. [FP] advice) if they recommend that an existing or proposed trustee/member of an SMSF purchase RP through their SMSF. This is because the vehicle is an SMSF and an interest in an SMSF is a [FP]. An adviser who suggests a loan to an SMSF with individual trustees for residential property investment may require an Australian credit licence ( ACL ) but not if the SMSF has a corporate trustee Advisers must be aware of the AFSL, ACL and other LRBA issues

31 Planning Using related party LRBA in conjunction with div 7A loan could become a popular strategy Advisers also need to ensure they operate within the law when assisting with LRBAs, eg, AFSL, ACL or legal advice Many SMSF fall behind with related party loans Banks take swift follow up action on any default The implementation and documentation for related party LRBAs is varied Document packages may include a template mortgage but has that been: executed correctly; or registered on title?

32 Planning Bank scrutiny can give rise to issues, eg, a change of trustee that was not done correctly or a missing deed, etc Auditors also have to be more like blood hounds when determining all is in order review contracts, legal documents, etc Legal review would also be worthwhile to ensure the legal issues are tied down

33 CONCLUSIONS

34 Conclusions Non-bank financed LRBAs should be carefully reviewed Rectify any issues prior to 31 January 2017 Ongoing monitoring required to ensure there is no risk Refinance with a bank LRBA to reduce risk If finance is available to contribute to reduce borrowings prior to 31 January 2017, then you may wish to take advantage of the possible concession to the $500k lifetime cap Comprehensive and balanced advice when implementing new LRBAs that are not with a bank (AFSL?)

35 Abbreviations and disclaimer AFSL: Australian Financial Services Licence ASIC: Australian Securities & Investment Commission LVR: Loan to valuation ratio LRBA: Limited recourse borrowing arrangement PCG: Practical Compliance guideline 2016/5 NALI: non-arm s length income NTLG: National Tax Liaison Group RBA: Reserve Bank of Australia These notes are a general guide only based on our view of PROPOSED CHANGES and the law as of the date below. PROPOSED CHANGES MAY NEVER BE FINALISED AND MAY CHANGE SUBSTANTIALLY BEFORE BEING IMPLEMENTED. These note are therefore no substitute for expert advice. Anyone seeking to rely on these notes should obtain expert advice to confirm particular issues especially as the PROPOSALS and the law are subject to ongoing changes and substantial penalties can be imposed. We are not licensed to provide financial product advice under the Corporations Act 2001 (Cth). Copyright resides in DBA Lawyers unless another source is noted. Date: 12 August 2016

36 Thank you Please complete your evaluation forms and return them to the registration desk

37 Author s name, Company 2016 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this presentation and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.