Can you lend money to your SMSF at a low interest rate ?
A recent interpretative decision by the ATO (ATO ID 2010/162) has caused some comment in the self managed superannuation industry, as on first look it appears that it allows a related party of a SMSF (say a member, or a member relative) to lend money to a SMSF under a limited recourse borrowing arrangement, and to do so under terms that are favorable to the SMSF. For example, say a member of a SMSF lends money to their SMSF under a limited recourse borrowing arrangement, but only charges the fund a very low interest rate, well below the normal market “arms length” rate.
Firstly, lets look at the actual issue the ATO raised, as follows:
“Does a self managed superannuation fund (SMSF) trustee contravene section 109 of the Superannuation Industry (Supervision) Act 1993 (SISA) if it borrows money from a related party of the SMSF under a limited recourse borrowing arrangement on terms favorable to the SMSF?”
(Note: Section 109 of the SISA deals with the issue of transactions where the other party to the transaction is not at arm’s length to the SMSF e.g. a fund member. The provision requires that the terms and conditions of the transaction must not be more favorable to the other party than would be reasonably expected if the parties were at arm’s length.)
The ATO answer was no, this situation does not contravene section 109. Specifically :
“The terms cannot be more favorable to the related party than would have been the case had the parties been dealing at arm’s length, but there is no contravention of section 109 of the SISA if the terms are more favorable to the SMSF.
Do you see the distinction ? The related party cannot get favorable treatment, but the SMSF can.
In our example, say Jim lends money to his self managed super fund under a limited recourse borrowing arrangement, but only charges the fund 2% p.a. interest, when the going market rate if they had been dealing on an arms length basis was say 8% p.a.
Jim (as the other party) is no better off, as he is getting less interest than he normally would, but the SMSF is better off as it is paying less interest. This ATO decision is highlighting the fact that section 109 only deals with the fact that the “other party” (in this case Jim) cannot be better off, but there is no restriction on the SMSF being better off.
So does this mean its open slather on this sort of thing ?
Well, not necessarilly. You always have to remember with DIY superannuation funds, just because something is OK under one provision, it does not mean it is OK under all SIS provisions. What you may well find is that the difference between the actual rate charged, and the arms length market rate may be deemed as a contribution.
Townsends lawyers have the following to say about it, and we think its prudent counsel:
“The Interpretative Decision while technically correct suggests that s109 is in need of reform. And most likely will be reformed. While it is possible to shift value to the SMSF using s109, the ATO has also specified in TR2010/1 that shifting value to an asset owned by the provider is a contribution. (Though the concept of a deemed contribution, in the absence of any market value rules, is more in the mind of the Commissioner than supported by any legislative text). Alternatively, the Commissioner could treat the income arising from the asset acquired by the mates rates loan as being non-arms’ length income and taxed at 45%. There is more legislative substantive supporting this claim than the deemed contribution.
So before moving into mates rates loans, a close look at s295-550 of the Income Tax Assessment Act, 1997 is highly recommended.”
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