Townsends solicitor Jeff Song said in the current low interest rate environment, there has been an increased interest in refinancing an existing limited recourse borrowing arrangement (LRBA) with a related-party lender.
“For this financial year, the minimum interest rate under the ATO’s safe harbour guidelines is 5.10 per cent per annum which, in most cases, would be lower than what would have been available to the trustees when they originally acquired the property using an LRBA,” Mr Song said.
“While the refinancing option could mean significant savings in monthly repayments for the SMSF, trustees should carefully consider the SIS Act compliance requirements in refinancing an LRBA with a related-party loan, which could be more onerous to comply with than maintaining the LRBA with a bank.”
Mr Song explained that the SIS Act provides for refinancing under limited recourse borrowing arrangements when the borrowed money is applied to refinance a borrowing in relation to the single acquirable asset.
This means the new loan from the related party must be made in relation to the same property and no other acquirable asset.
“The loan documentation should be drafted accordingly and formally establish a sufficient link between the loan and the property as the only security for the loan,” Mr Song said.
Secondly, the money so borrowed from the related-party lender must be applied solely for the purpose of replacing the financing arrangement from the earlier arrangement with the outgoing bank.
“The amount of the new loan, therefore, must not exceed the amount required to pay out the bank in respect of the original LRBA,” he said.
SMSF trustees also need to ensure that the usual LRBA conditions are maintained in the new arrangement including the requirement to have the property held on trust (i.e. holding trust) and limiting the recourse of the lender or any other person in the event of default to only the property.
Trustees should also be able to demonstrate that the refinancing is for the sole purpose of retirement benefits for the members.
“An example of a possible contravention is where the SMSF trustees decide to refinance with a related party on materially similar (or inferior) terms in order to provide additional income source to a struggling related party,” he cautioned.
The Superannuation Industry Supervision Act 1993 (SIS Act) also requires SMSF trustees to deal with third parties at arm’s length, he added.
“This is a critical requirement, as it can be a criminal offence to breach the requirement. Additionally, a breach may result in the income arising from the transaction being taxed at the top marginal rate of income tax (i.e. non-arm’s length income or NALI).”
He also noted that the measure introduced by Treasury Laws Amendment (2018 Superannuation Measures No 1) Act 2019 applies to LRBAs where the lender is an associate of the SMSF or the member or members participating in the LRBA have satisfied an unrestricted release condition.
