Draft legislation has been released for comment aimed at closing off two avenues in which the Government considers LRBAs could be used to circumvent contribution caps.
The first of the Government’s proposed changes will include a member’s share of the outstanding loan balance of an LRBA in the member’s Total Superannuation Balance. It will only apply to SMSFs and Small APRA Funds (SAFs).
In other words, a single member fund with a $2m asset and $500,000 LRBA (so net balance of $1.5m) will – under the new provisions – have a Total Superannuation Balance of $2m rather than $1.5m.
Since one of the main uses of Total Superannuation Balance is to limit a member’s future contributions, increasing it in this way will have the effect of:
- stopping a member from making non-concessional contributions to superannuation if his or her share of the gross assets of the fund exceeds $1.6m (the example of the single member fund above); and
- stopping a member from carrying forward unused concessional contributions from 1 July 2018 if his or her share of the gross assets of the fund exceeds $500,000.
This measure is only proposed to apply to LRBAs entered into from 1 July 2018. It is something trustees and their advisers need to be aware of if considering new LRBAs as it will potentially impact their feasibility if future non-concessional contributions were anticipated to repay the borrowing.
The second of the Government’s proposed changes ensures that expenditure is also taken into account when determining whether the non-arm’s length income tax rules apply to a transaction. Whilst not necessarily a SIS breach, remember that if considered to be non-arm’s length, income is taxed at 47% not the concessional 15% rate (or 0% for income earned on assets supporting a retirement phase pension).
The proposed changes have not been specifically limited to LRBAs and therefore apply to any “unreasonably low” expenditure incurred in deriving income. Arguably it addresses a gap that has always existed in the non-arm’s length income provisions – they only required that the income received in relation to a particular asset was arm’s length and did not explicitly prevent SMSFs from achieving a similar result by artificially suppressing costs.
Clearly, however, the main target is LRBAs involving loans from related parties where the arrangement is not on arm’s length terms. For example, where the interest rate charged is less than the rate charged by a third party financial institution or is not in accordance with the safe harbour provisions of PCG 2016/5.
The proposed changes would mean that under these circumstances, the income (including capital gains) earned by the asset acquired under the LRBA would be taxed as non-arm’s length income (albeit the interest would be a deductible expense under the usual rules).
This second change is proposed to apply to income derived from 1 July 2018, regardless of whether the arrangement was entered into before 1 July 2018, and effectively gives legislative backing to what the Government attempted to do with the safe harbour rules. Presumably this would include any capital gain realised after 1 July 2018 regardless of when the growth in the asset actually occurred.
These measures are open for consultation until 9 February 2018. We’ll let you know how they proceed.