On 6 April 2016 the ATO issued guidelines on limited recourse borrowing arrangements (LRBAs) between self-managed superannuation funds (SMSFs) and related parties.  PCG 2016/5 sets out the ATO’s views about when a loan from a related party to an SMSF will be treated as an arm’s length dealing.  If the LRBA is treated as a non-arm’s length dealing, the income from the investment may be treated as “non-arm’s length income” of the SMSF and be taxed at 47%.  The Guidelines identify the steps that you should take before 30 June 2016 to avoid ATO scrutiny.  

On 30 May 2016, the ATO announced that you will now have until 31 January 2017 to take action. Nevertheless, we recommend taking action sooner to properly plan for any required restructure, especially if the fund has arrangements similar to the ones described below.

Many LRBAs have been established where a person has borrowed money from a bank using the person’s home as security and then on-lent the borrowed money to the person’s SMSF on a “back-to-back basis”, so the loan from the individual to the SMSF mirrors the loan from the bank to the individual.

Although the loan from the bank to the individual is on commercial terms, the ATO guidelines mean that the loan from the individual to the SMSF may not be treated in the same way.  This is because:

• Although in practice arrangements operate on a “back-to-back” basis, there may be nothing in the loan agreement that compels this to occur. 
• Although the LRBAs usually provide that the SMSF may be required to provide security, this often does not occur.  
• The commercial lender’s loan to the individual generally will have a lower interest rate than would be payable if the bank had made the loan directly to the SMSF.  This is because the loan to the individual is full recourse and is usually based on the “owner-occupier” interest rate whereas the loan to the SMSF is limited recourse and should be on the higher investment interest rate.

SMSFs that have LRBAs with related parties should review the arrangements now and restructure the arrangements before 31 January 2017 to:

• Amend the loan agreement
• Make additional “catch-up” payments, and
• Register a mortgage over the SMSF’s property.

If you require help with reviewing and or potentially updating the terms of a loan agreement in a LRBA so that it comes within the scope of the Guidelines, please contact Thalia Dardamanis or Patrick Cussen on 1300 267 529.

Are you risking the small business CGT concessions?

Many people when drafting wills want to make provision for one person (usually a spouse) for the term of that person’s life.  This is frequently achieved through the creation of life interests.

Life interests can raise a host of tax problems.

The use of life interests in estates raises serious tax issues if the beneficiaries of the estate wish to wind up the estate and pay out the life interest holder.

We recently encountered a different problem with a life interest involving the operation of the small business CGT concessions.

We were asked to provide advice to the executors of an estate where the major asset of the estate was a farming property.  The deceased had made provision under his will for his wife to have a life interest with the balance of his estate to be shared equally between their children.

When the family looked to sell the property they were disappointed to hear that although the family had been actively operating the farm for over 30 years, the sale did not qualify for the small business 15-year concession or the small business retirement concession.  Because the life interest holder was entitled to 100% of the income but had no entitlement to capital, there was no “significant individual” in relation to the estate.

There are a range of ways in which this result could have been avoided.  For example, the use of a testamentary trust with broad powers to distribute income and capital combined with a personal right to occupy the farm house for as long as the widow wished to do so, would have provided the widow with protection but also should have allowed the estate to sell the farm and claim these CGT concessions.  

Although the issue for our client related to a farming property, the same issue can arise with any type of business asset if a person creates a life interest under a will.

These are issues that can easily be avoided with a more appropriate estate plan.

Bernie O’Sullivan, Rob Warnock, Patrick Cussen and Thalia Dardamanis can assist you with tax effective estate planning.

It is relatively common for the trustee of a trust to transfer an asset to a beneficiary of the trust for no consideration.

A transfer of real property to a beneficiary in this way often qualifies for exemption from duty in Victoria, so it is a common step in restructuring ownership of assets.

If a trust transfers an asset to a beneficiary for no consideration, the trust is treated as disposing of the asset for its market value for capital gains tax purposes.

There is a twist in determining who will pay tax on that capital gain.

A beneficiary who receives the financial benefit referable to a capital gain generally is treated as being “specifically entitled” to the gain and will pay tax on that gain.  

If a trustee of a trust transfers an asset to a beneficiary, it would appear logical that the beneficiary would be treated as specifically entitled to the gain arising on the disposal of that asset by the trust and be subject to tax on that gain.

Not so.  

Section 115-228(3) of the Income Tax Assessment Act 1997 provides that in calculating the amount of the capital gain the trust must “disregard sections 112-20 and 116-30 (Market value substitution rule) to the extent that those sections have the effect of increasing the amount of the capital gain”.  

In other words, the beneficiary is not treated as specifically entitled to the gain arising on the disposal of the asset transferred.

This means that although one beneficiary may receive an asset from a trust, another beneficiary or the trustee may be required to pay tax on the gain arising on the disposal of that asset.

If a trust transfers an asset to a beneficiary for less than its market value, the trust should be very careful about how it frames:

1. the resolution to transfer the asset; and
2. the distribution minute resolving to distribute the income of the trust.

Contact Patrick Cussen or Rob Warnock if you have any questions about this issue.