LRBA safe harbour interest rates (2020)
The ATO PCG 2016/5 sets out the “safe harbour” terms on which SMSF trustees may structure their LRBAs consistent with an arm’s length dealing. Further to this, the ATO publishes annually the safe harbour LRBA rate for SMSFs. This article provides the applicable rates for 2020-21 (both safe harbour and Divison 7A benchmark interest rates), the related proposed Division 7A changes and implication for LRBAs that do not meet the safe harbour rates or other terms.
Importantly LRBAs that do not meet the safe harbour terms fully will not automatically be deemed to be dealing on non arm’s length terms. Rather the onus will shift to the trustee to demonstrate that those LRBA terms were entered into and consistent with an arm’s length dealing.
2020-21 applicable lending rates
The ATO SMSF safe harbour interest rate is the RBA rate for a “standard variable housing loan for investors”. For 2020/21, the revised safe harbour interest rate is 5.10% for real property and 7.10% for listed shares or listed units.
Where the SMSF LRBA lender is a related private company, the LRBA loan terms may have to meet in addition the requirements of Division 7A Part III of the ITAA 1936. Under Division 7A, the benchmark interest rate for an income year is the RBA rate for a “standard variable housing loan for owner-occupier”. For 2020-21, this benchmark rate is 4.52%.
Proposed Division 7A changes
In the 2016-17 Federal Budget, the Government announced targeted amendments to Division 7A. A single 10- year loan model will be used instead of the existing 25-year and 7-year loans. The interest rate will also be revised to the RBA overdraft rate for small business which is usually 2% higher than the current benchmark rate.
The amendments were to apply from 1 July 2019 but has since been postponed to the income year commencing on or after date of royal assent of the enabling legislation. There will also be further consultation on safe harbour rules, loan duration and minimum interest rate and measures to improve integrity.
LRBAs that do not meet PCG 2016/5 “safe harbour” terms
An ATO SMSF News Alert summarises the position.
“For SMSF trustees with LRBAs which do not meet the “safe harbour” terms in PCG 2016/5 they cannot be assured that the Commissioner will accept the arrangement to be consistent with an arm’s length dealing. However, this does not mean that the arrangement is deemed not to be on arm’s length terms. It merely means that there is no certainty provided under the guidelines in the PCG. Trustees will need to be able to otherwise demonstrate that the LRBA was entered into and maintained on terms consistent with an arm’s length dealing. This may include evidence to show that the terms of the particular LRBA replicate the terms of a commercial loan that is available in the same circumstances.”
Replicating the terms of a commercial loan do not relate only to the interest rate but all other terms such as duration, loan to value ratio, security, payment frequency.
Commercial non-bank lenders generally charge LRBA interest rates at par with or higher than the safe harbour rate. Bank lenders have for the time being dropped out of the LRBA market. A related party lender may also provide limited recourse loans to their SMSF, subject to applicable rules. A consistent low interest environment is a favourable factor for SMSF borrowings, but the considerations in relation to LRBA are many folds. The ATO publication below provides good guidance on LRBA investment considerations:
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