The Australian Taxation Office (ATO) as part of its response to the coronavirus pandemic (COVID-19) indicated that it would not apply compliance resources for the 2019-20 and 2020-21 financial years for SMSFs that sought loan relief for LRBA related party loans.
This relief applied for related party loans that complied with the safe harbour guidance set out in PCG 2016/5. Furthermore, where the fund deferred the LRBA in line with the guidance published by the Australian Banking Association (ABA), then the Commissioner held that the arrangement still satisfied an arm’s length arrangement for income tax purposes.
Where the loan is provided to the SMSF by a private company, there are a number of important requirements that must be met for the loan to comply with Division 7A in the ITAA 1936. Section 109N of the ITAA 1936 sets out the conditions for a loan to be explicitly exempted from being deemed a dividend, which includes:
- The loan being made under a written agreement
- The loan has a minimum interest rate, and
- The loan has a maximum loan term.
To comply with the requirements of Division 7A, a minimum repayment is required to be made every year, with an amount of interest charged in line with the benchmark interest rate (available from ATO website). However, with COVID-19 relief available for SMSF trustees impacted during this period, there has been eligibility to capitalise loan repayments (6 months initially, then potentially for a further 4 months thereafter).
Whilst the ATO has provided compliance relief in respect to the safe harbour terms in PCG 2016/5 (which permits loan capitalisation), it was unclear whether this would create a breach of Division 7A and result in the SMSF having to treat the loan as a deemed unfranked dividend, which would have adverse tax implications for the fund.
The ATO has now confirmed that where the entity satisfies all other conditions for the Division 7A loan, then an unfranked dividend will not apply due to the COVID-19 compliance relief. Importantly, taxpayers must apply for the administrative relief if they are unable to make the minimum yearly repayments on any Division 7A loans by the end of the lender’s 2019-20 income year.
To understand this further, let’s explore the issue by way of example:
Ken and Sally have a SMSF in which they are both members and directors of the corporate trustee. They purchased real property using an LRBA to operate their travel agency, with the loan financed by Salken Pty Ltd (a private company acting as trustee of their family trust).
Due to COVID-19, the fund sought loan repayment relief which followed the rental relief provided by the fund to their business as per the mandatory code of conduct for commercial tenancies.
Ordinarily the fund would be required to make a minimum loan repayment to Salken Pty Ltd for the purposes of Div 7A to ensure that the loan is not treated as an unfranked dividend. However, for the 2019-20 year, Ken and Sally seek administrative relief from the ATO in respect to the minimum yearly repayment not being met. On the basis that all other conditions are satisfied, no unfranked dividend will occur in this situation.
The ATO has now published information on their website with further information about ‘requests to extend time to make minimum yearly repayments for COVID-19 affected borrowers under section 109RD’, including the form to be completed and lodged with the ATO for relief to apply: