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I have an SMSF where members have borrowed from the bank at 3.07% interest and on lent to their SMSF at 6.5% interest rate resulting in them profiting at 3.43% personally from the SMSF. They have used this loan to purchase a property in the SMSF. Is such an arrangement allowed? Please advise which section of the SIS Act it may have breached.
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Hi Jan
As a starting point a SMSF can borrow from a related party to purchase property (& other assets) by using a limited recourse borrowing arrangement. A member could borrow from a bank & then lend to a SMSF if the SIS limited recourse borrowing rules (LRBA) are complied with.
The ATO has issued guidance on related party LRBA's & the interest rate is covered by the "safe harbour" rates. You can see the rates at:
www.ato.gov.au Key superannuation rates and thresholdsThese are the key rates and thresholds that apply in relation to contributions and benefits, employment termination payments, super guarantee and co-contributions.
My concern is the rate being charged to the Fund does not agree with the "safe harbour" rates. Using a higher interest does not mean that the arrangement is deemed to not be on arm's length terms however the trustees will need to be able to demonstrate that the terms are consistent with an arm's length dealing.
The ATO does address the issue of a higher interest rate & they note that:
"Related parties on-lending money at a higher interest rate
A related party can on-lend money to the SMSF under an LRBA at a higher rate of interest provided the:
limited recourse loan to the SMSF by the related party is appropriately documented
SMSF is not charged higher than an arm's-length rate of interest for borrowing
arrangement under which the SMSF borrows from the related party otherwise meets the requirements of the super law."
You should also refer to PCG 2016/5 - "Income tax - arm's length terms for Limited Recourse Borrowing Arrangements established by self-managed superannuation funds".
Thanks
SMSF AAA