As we enter the new year, taxpayers with related party loans (including SMSF trustees) should review their loan arrangements.
NEW INTEREST RATE FOR RELATED PARTY LRBAS
“Tradition is peer pressure from our ancestors … or the ATO”
Since 2016, SMSF trustees with related party loans have had a new tradition every July: readjusting interest rates on their related party limited recourse loan agreement.
After the ATO issued Practical Compliance Guidelines 2016/5, most SMSFs have maintained their related party LRBAs in accordance with the Safe Harbour terms set out in those guidelines. Those terms Safe Harbour terms call for the interest rate to be adjusted every year in July.
Happily, after four straight years of increases, the interest rate has been reduced to 5.10%. This is down from last year’s rate of 5.94%.
SMSF Trustees using the Safe Harbour terms under PCG 2016/5 should adjust their repayments accordingly to make sure the correct amount of interest is charged.
DIV 7A AMENDMENT UPDATE
Few things have been as difficult to advise on or predict as the implementation and operation of the long-threatened amendments to Division 7A of the Income Tax Assessment Act 1936.
The Government has recently made further announcements on this matter.
Division 7A treats certain loans and other payments as deemed dividends unless the arrangement complies with the provisions of Div 7A.
Amendments to these famously tricky rules were first proposed in the 2016-2017 Budget. It was originally intended that these amendments would take effect from 1 July 2019. However, after industry consultation in late 2018 revealed widespread confusion and highlighted complexities in implementation, this date was deferred to 1 July 2020.
The ATO says that the proposed amendments are intended to simplify the operation of Div 7A (as well as provide a self-correction mechanism for inadvertent breaches). Although the proposed amendments may be simpler, this is a mixed blessing as simplicity has been realised by making standards generally more stringent. We are still awaiting legislation, however the amendments will:
- Remove the distinction between secured 25-year loans and unsecured 7-year loans by mandating a single 10-year loan term.
- Change the annual benchmark interest rate by fixing it to the RBA overdraft rate. In effect, this represents a considerable increase as follows:
- The current Div 7A Benchmark rate for year ending 30 June 2021 is 4.52% (down from 5.37% for the year just ended).
- Both rates are substantially less than the 6.57% that would now be payable had the Div 7A amendments come into effect on 1 July as scheduled.
- Extend the review period to 14 years after the relevant loan, payment or debt forgiveness was completed.
- Treat unpaid entitlements as subject to Div 7A.
Uncertain Start Date
In June, the government announced that the Div 7A amendments are now only scheduled to come into effect with a start date of the beginning of the income year commencing after the legislation receives royal assent. As the legislation for the proposed amendments has not been passed, the start date remains up in the air.
Div 7A and COVID-19
On 26 June 2020, the Commissioner announced that borrowers who are unable to make their obligatory yearly Div 7A repayments by 30 June can apply to defer their minimum yearly repayments for 12 months. The Commissioner may grant a deferral by exercising his discretion under section 109RD (which permits him to disregard a deemed dividend).
It should be noted that unpaid interest cannot be capitalised.
The application to extend repayment until 30 June 2021 would be subject to the ATO’s approval. Ultimately, a taxpayer wouldn’t know if the Commissioner would agree to exercise his discretion until after the date to make a repayment (or declare a dividend) had passed (and at any rate that date, being 30 June, has now passed), so this avenue should only be relied upon in cases of genuine need.
Although this is welcome relief, borrowers would need to consider any other legislative obligations to which they may be subject.
In the case of SMSF borrowers who are borrowing from a related party that must comply with Div 7A, the SMSF trustee must also be mindful of their various other obligations under the SIS Act and PCG 2016/5, which may not permit a deferral or repayments.
Div 7A and LRBAs
SMSFs that borrow from related parties that are subject to Div 7A occupy a curious space, whereby they must simultaneously satisfy PCG 2016/5 and Div 7A.
Div 7A and PCG 2016/5 do not impose identical standards. Typically, the more stringent requirements as to interest rate, loan terms and so on should be applied.
From the above discussion, it should be noted that the proposed new Div 7A terms mandate both a shorter loan term and a higher interest rate than PCG 2016/5.
This means that related-party LRBAs in the future may require substantially higher loan repayments and shorter loan terms when borrowing from a related company.
If you have any questions, or would like to know more, please email our Legal Senior Associate Christian Chenu or call 1800 333 143.