(03) 9020 2905PORTFOLIO POINT: What!? A no-interest loan to your SMSF? Maybe, but don’t rush in just yet. For now, just watch this space.
Sometimes regulators work in mysterious ways. Very mysterious ways.
There is a bit of a buzz in the upper echelons of the world of SMSF professionals in regards to some recent utterings from the ATO in regards to SMSF lending.
Lending to your SMSF at a 0% interest rate could, it appears, be possible. More importantly, possible without risking the ATO’s wrath in regards to the lack of interest being charged essentially being deemed a contribution to the SMSF.
Pardon?
Is this a way to potentially get a bucketload more into your SMSF? Well, possibly, yes. But with GREAT caution, I advise anyone whose ears just pricked up to please sit on the sidelines and watch for a little while. Await further news on this topic.
I’ve written in the past (including this column on 21/4/10) that it is possible for the individual members of a SMSF to play the role of banker in any deal that includes limited recourse borrowing arrangements (LRBAs). The column also mentions that individuals should be careful when lending money to the SMSF that they charge a commercial interest rate. An interest rate that is too high could be considered to be the individual receiving a benefit from the super fund paying out too much. An interest rate that is too low could be seen, and deemed, to be a defacto contribution to the fund.
If it was deemed to be a defacto contribution to the fund, it could be a real problem if the members had already contributed to super up to their limits (concessional and non-concessional) and the deemed contribution pushed them over their contribution limits.
That has been the general consensus. Until now.
The ATO has recently suggested that an interest rate that is in favour of the SMSF would not necessarily be deemed a contribution. Even if that interest rate was 0%.
The statement is contained in the notes to the “superannuation technical minutes June 2012” of the National Tax Liaison Group (NTLG).
The ATO clearly states there that there must be a genuine loan agreement in place. And that if the interest payment for the loan is paid by a third party, forgiven or reimbursed, then it would fall outside of this notice.
Specifically, the ATO was asked a series of questions in regards to “related party” loans by the industry panel that meets for the NTLG. Related party loans, as the name suggests, are where the loan is made to the SMSF by a party related to the super fund – which will mostly be someone who is a member of the fund.
The ATO was specifically asked if an artificially low interest rate was charged by the super fund, would that constitute a contribution to the SMSF for the purposes of concessional and non-concessional limits.
The answer was “no”. And it has surprised the industry. You could hear the penny drop.
“The absence of a requirement to pay interest on money loaned to the trustee does not increase the capital of the fund. A saving on an expense of an SMSF … does not fall for consideration if there has been no increase in the capital of the fund,” was the ATO’s response.
“The outcome is different if, for example, interest incurred by the fund is paid by a third party, forgiven or reimbursed. In all of those circumstances the capital of the fund is increased as the interest liability has been met by a third party or forgiven or an amount has been reimbursed to the SMSF.”
And what about if the interest rate was 0%. Would that still constitute a loan for the purposes of the Act?
“Yes,” was the reply. While an interest rate being charged was evidence of a borrowing, it is not a “necessary feature”. The ATO went on to suggest that if the loan conditions were in favour of the SMSF, that was okay.
If loan conditions favoured the lender, then … not so much. Presumably because that would be treated as receiving a benefit from the SMSF.
“If such a borrowing is entered into between an SMSF trustee and a lender that is a related party of the fund, a fact that the borrowing is interest free does not cause a contravention of paragraph 109(1)(b) of the SISA as that fact does not make the terms and conditions of the borrowing more favourable to the related party lender than would be reasonably expected if the parties were dealing with each other at arm’s length in the same circumstances.
So, what does it mean?
Um, probably a lot of trouble. My strong advice is to wait until this has been kicked around a whole lot more by the industry’s experts. That is, keep a watching brief. It seems a little too good to be true. And you know what they say about things of that nature.
At one extreme, it would be, essentially, a way to get around the contributions caps.
Let me paint a quick scenario. Let’s take a couple with a $1 million SMSF. They have got there by making their full entitlements of $25,000 a year (each) in concessional contributions. And, further, in recent years, they have maxed out their non-concessional contributions of $150,000 a year also. That is, there is no way to contribute extra into their super fund, apart from the future eligibility to make contributions.
However, they decide to purchase an investment property via a loan to their super fund. They purchase the property for $500,000, including a loan of $400,000. The property produces $20,000 a year in rent.
Until this utterance from the ATO, it was assumed that the SMSF would probably need to pay an interest rate of somewhere between 5.5% and 7.5% (based on the current situation for interest rates).
Let’s settle on 6.5%. On a $400,000 loan, that’s an interest bill of $26,000 and the property has other costs of $5000 a year. Total costs of $31,000.
However, what happens if the individual (and member) charges the SMSF an interest rate of 0%? Quite a few things, actually. And it’s the following that probably gives a better indication as to why the ATO has made its decision, while at the same time, raises further questions.
- The SMSF becomes positively geared to the tune of $14,000. If the SMSF is in accumulation mode, the $14,000 would become taxable income, with no offsetting interest expense.
- If the fund is in pension phase, then the positively geared income would (presumably) not be taxed.
- If the individual has borrowed the money from a commercial lender (bank) to lend to the super fund, he or she will be paying interest on that loan. However, if there is no income coming in the form of interest payments from the SMSF, then the loan is unlikely to be a tax deduction for the individual.
- If a low interest rate is charged to the SMSF, say 1%, but a rate of 7% was being paid to the bank by the individual, would the difference be claimable as a negative gearing expense to the individual outside super?
Under extreme circumstances …
There is plenty to be optimistic – for a select few potentially able to take advantage of these circumstances – about when it comes to the ATO’s comments. But, at this point, until some of the industry’s smartest brains have had a chance to digest it, I urge you to simply watch this space.
In the above example, if no interest was charged, the fund would not have to pay $26,000 in interest that might otherwise be considered a legitimate expense of the super fund.
That’s $26,000 in expenses that gets to stay in the SMSF. The ATO is saying that it would not necessarily be considered a super contribution – so long as, importantly, the rest of the conditions laid out were followed.
And that, essentially, is how the ATO seems to have seen it. It’s not a contribution to the fund. It’s money that’s staying in the fund. Technical difference, sure, but it explains why the ATO has made the decision.
As previously warned, just keep your ears open to news in this space and for the opinions of the “experts”. They’ve been pretty quiet to date. I first read of this decision weeks ago, but have been waiting to read more about it from people who are obviously just as cautious about the decision as I am.
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The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.
Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.