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Situation
SMSF has loaned $300,000 on 14 Jul 2016, $200,000 on 27 Nov 2017, $100,000 on 29 June 2018 and $200,000 on 28 Mar 2019 to the same single non-related party. I was provided a fully executed Loan Deed with Terms as follows: Repayment of all the principal amounts above by 30 June 2020, interest of 15% paid at the end of the loan term, secured by title. The money is being used to develop a subdivision on the land which is securing this loan, and developing land adjacent to this land (which is also be owned by the borrower).
Potential Issues
Potential problem 1: Loan Repayment date of 30.06.2020 has been exceeded per the supplied loan deed (agreement), and the loan deed also states the loans made in 2016 and 2017 have been replaced by the current loan deed (agreement). When loan repayment terms are not being met on one or more occasions, does this potentially pose a recoverability issue and perhaps contravention of market value?
Potential problem 2: No regular repayments of principal and interest - the fund has not recieved any principal and interest from the date the money was loaned out - im told this was to be repaid to the fund at the completion of the development and, as the development has not been completed at 30 June 2020 principal and interest has not been received - in essence they are waiting for the development to complete before they get their money - Does this become an arms length issue in itself?
Potential problem 3: Interest rate appears high @ 15% on a secured real property
Potential problem 4: Interest is not being capitalised & a principal and interest calculation schedule has not been provided.
Question
Can you be specific in your response to all potential problems in this case if possible. In your view, do you see arms length (s109) or any other issues (r8.02B) here OR is it a case that because the borrower is not a related party and the terms have been stated in the loan deed (Agreement) then this is an acceptable commercial arrangement (meets s109)?
Hi Mark
In terms of the compliance audit, I would consider the following sections / regulations of SIS:
1) Section 62 - sole purpose test. An interest rate of 15% sounds high for a secured loan. As long as the loan terms / rate is commercial then it should not be a breach of the sole purpose test. I would request a response from the trustees as to how this rate was determined. Lenders such as Balmain do often lend for development loans at approximately 10% (secured) so a rate of 15% may be reasonable / commercial depending on the situation.
2) Section 82 - 85 - in-house asset (IHA) rules. Your heading suggests the loan is not to a related party. You would need to obtain paperwork to support that the loan is not to a related party.
3) Section 109 - arm's length rules. Investments must be made on an arm's length / commercial basis. It would be commercial to rollover the loans as long as the trustees had documented why this was done. The receipt of interest at the end of the term is documented in the loan agreement. The non payment of principal / interest is only a breach of section 109 if the terms are not commercial. As stated above the trustees need to document / explain the reasons why the loans were extended / rolled over.
4) Reg 8.02B - asset must be valued at market value. As the loan is secured against property I would do a title search & request a valuation of the property to help determine if the loan is collectible. In my view the interest should be accrued as it is an asset of the Fund and it would appear to be material to the Fund. A schedule should be obtained of the interest owing and it should be reflected in the financial statements. If the interest is not being accrued the assets of the Fund are being undervalued. You would again have to try & assess if the principal and interest is capable of being paid to determine if the market value is reasonable.
Thanks
SMSF AAA