Speaking to SMSF Adviser, DBA Lawyers director Daniel Butler explained both decisions confirm that nil interest borrowings from related parties can cause non-arm’s length income (NALI).

Mr Butler pointed to some key points for SMSF practitioners to note from these decisions, including that unless related party limited recourse borrowing arrangements (LRBAs) align with arm’s length terms and conditions, the income is likely to be taxed as NALI, with the exception of where the SMSF has obtained a prior favourable private binding ruling.

He also noted that SMSF trustees with related party LRBAs should now ensure they have well-documented “benchmark” evidence to indicate that they satisfy the arm’s length terms and conditions.

Essentially, SMSF trustees should ensure related party loans are made on commercial terms, meaning that interest is being charged, for example, and if the loan is benchmarked to a bank’s variable interest rate, that rate is revised in line with bank changes and regular loan repayments are being made.

However, Mr Butler stressed related party loans still play a valuable role, provided they are strictly on an arm’s length basis.

In fact, Mr Butler said related party loans are on the rise in light of fears LRBAs will be banned following the Financial System Inquiry's recommendation to prohibit borrowing in super. 

“In view of the fear that LRBAs could be prohibited outright … we are recommending to clients that if there’s a long settlement period, particularly with off-the-plan [properties,] that they put in place a related party loan arrangement, just in case the rules change.”

“If you don’t have a related party loan in place, you might get caught out because your grandfathering is likely to be on the basis of [whether] you have what is termed an existing loan in place.”

Following the publication of these decisions, there is still lingering uncertainty as to what the ATO will do with SMSFs that have related party LRBAs that do not meet the arm’s length terms and conditions.

The ATO also have still to announce what is an acceptable ‘safe harbour’ LRBA and the industry is anxiously awaiting this news, Mr Butler said.

“SMSFs that are not benchmarked should consider doing so before any ATO audit activity occurs. Hopefully, the ATO may provide an amnesty to encourage SMSFs to benchmark to arm’s length. The big question here is whether the ATO will require retrospective adjustment.”

For detailed analysis from DBA Lawyers director Daniel Butler, please click here.