In this edition of It Depends, senior associate Keeghan Silcock considers whether a related party can lend money to an SMSF.
An SMSF is generally prohibited from borrowing, but there are exceptions. Where the lender is a related party, the terms of the loan are critical.
Keeghan explains what those terms must look like and why the answer can differ depending on the borrowing structure involved.
Video transcript
Hi, my name’s Keeghan Silcock and welcome to another edition of It Depends.
Today, I’ll be talking about whether a related party can lend money to an SMSF.
So, it depends.
The starting point is that SMSFs are not permitted to borrow money. However, there are a few exceptions. The first most commonly available, I guess, is what is known as a limited recourse borrowing arrangement (LRBA).
And, another example where we see that SMSFs can inadvertently borrow is where they invest in an unrelated unit trust structure. So, the SMSF doesn’t own more than 50% of the interest, it doesn’t control that unit trust structure. Then, the unit trust can potentially borrow to fund its activities.
Now, the question is whether that SMSF with an LRBA or the unrelated unit trust structure could borrow money from a party who is related to the SMSF.
So, for an LRBA, there are two rules that one of them would have to be satisfied for a related party to lend money. The first is where that loan matches the loan terms that are provided for under the safe harbour guides. And, so those are guides which are being released by the ATO. There are two different options depending on the type of asset which is being acquired under the LRBA.
Importantly, for real property purchases, the LVR cannot exceed 70%. So, that’s one of the loan term requirements under those safe harbour loan provisions.
So, if you do not use the safe harbour loan term provisions which are provided by the ATO for a related party LRBA loan, then the only other option is to obtain independent third party evidence of what an unrelated lender would use as its loan terms to lend money to the SMSF for that exact transaction that you’re contemplating and those loan terms need to be in writing. So, for example, a written letter of offer and then obviously matched by the related party lender.
And if you don’t do this then we’re going to have a number of issues, the first of which being potential NALI – non arm’s length income issues.
For an unrelated unit trust structure, those safe harbour loan term provisions, which I was talking about for LRBAs are not available. So, we cannot have an unrelated unit trust relying on those provisions if it’s looking to borrow money from a related party lender, the only available option for an unrelated unit trust is to go out and get that independent third party evidence of loan terms, which I was talking about. So, basically the second option is the only one available to it.
Obviously it’s really important that the loan terms are properly documented in the normal way, commercial way that you would usually see, and those loan terms need to be in writing before any loan is made. Appropriate security needs to be taken and registered as at settlement.
It’s not just a point in time exercise as well. There needs to be ongoing compliance with those loan in terms moving forward.
So, if you have any questions regarding LRBAs or related party lending, please feel free to contact a member of our team.
