SMSF’s and the risks associated with related party loans

Tax time is approaching, and in 2015 the ATO signalled it had SMSF’s and related party loans in their sights.

Borrowing from a related party is a common tactic for individuals managing their SMSF, as the terms can often be favourable in comparison to what banks have to offer.  However, regulators are now raising concerns as to whether these loans are correctly benchmarked against commercial lending options.

A certain level of ambiguity has always existed in the SMSF space relating to whether a fund can enter into related party loans, and whether their might be consequences of such action should guidelines to be appropriately followed.

As a result of this uncertainty, the ATO released two Interpretive Decisions to attempt to clear up any perceived ambiguity. The ATO formalised their position as a result, and moved to form the view that if any related party loans are interpreted to be ‘non arms-length’, the resulting income should be taxed at the top marginal rate.

This view was formed on the basis that SMSF’s would not have entered into loans considered ‘non-commercial’ had the loan been established at arms-length, with market interest rates payable.

To avoid such judgement from the ATO, any SMSF entering into such an arrangement must create and retain documentation confirming the loan meets commercial lending rate benchmarks, and thus can be considered ‘arms-length’.

Given these warnings, SMSF’s are encouraged to exercise caution when considering entering related party loans.  Making sure that loans do not fall foul of the guidelines, thus becoming assessable income.  If you have already borrowed,  caution should be taken and be sure to review and document the terms of said loan to ensure an unexpected tax burden isn’t created as a result.

Further information can be found on the ATO website.