The ATO has recently warned that SMSF income generated from limited recourse borrowing arrangements (LRBAs) deemed to be uncommercial may be subject to high tax rates.
If a LRBA is found to be uncommercial then all income derived from the related asset can be taxed at up to 45% including rental income, dividends, interest and capital gains.
At this point no detailed guidelines have been released, and LRBAs are being assessed on a case by case basis to determine whether or not the high tax rate will be applied to related income. As such it is advisable to ensure that all loans taken out by your SMSF meet commercial terms. It is also recommended that all documentation is retained in case you are required to provide evidence of commercial loan conditions.
What makes a LRBA uncommercial?
A LRBA may be considered uncommercial if the terms result in a greater return than would be expected from a standard industry loan. Factors that may be considered by the ATO when assessing the terms of a loan include the loan to value ratio, interest rates that are below market value, and unusually long repayment periods.
The ATO has also indicated that LRBAs used to purchase assets with limited material security, for example shares, will be more likely to attract the higher tax rate, as it is unusual for commercial lenders to approve loans for these types of investments.