LRBAs at Sea and in the (safe) Harbour

The ATO issued on 6 April 2016 what it termed “practical compliance guidelines” in relation to limited recourse borrowing arrangements (LRBAs).  These guidelines are referred to as “safe harbour” guidelines as the ATO will accept that any related party LRBA (that is a limited recourse borrowing arrangement where the lender is not a commercial lender such as bank, building society, credit unit or finance company) the terms of which are entirely within the guidelines will not be treated as giving rise to non-arm’s length income.  This means that the income arising from related party LRBAs which are within the safe harbour will not be taxed at 47% but taxed at 15% or be taxed exempt if in pension phase.  Conversely for related party LRBAs which are at sea, and without the availability of a benchmarking life boat, the income arising from the LRBA will be taxed at 47% - even if the superannuation fund is in pension phase.

The particular issues to be considered are: when will an LRBA be at sea, when is a benchmarking life boat available and when will the LRBA be in the (tax) safe harbour?

Historical Background
The recently released (6 April 2016) safe harbour guidelines have had a long gestation. In order to prevent exploitation of the tax concessions provided to superannuation funds, taxation legislation included special taxing provisions which were aimed at arrangements under which “value” was transferred to superannuation funds.  Value shifting could occur if the superannuation fund acquired an asset from a related party at less than its market value.  Value shifting could also occur if a related party loaned money to the superannuation at very favourable rates.  

In the context of limited recourse borrowing arrangements (LRBAs) two provisions were particularly relevant: s109 of the SIS Act and s295-550 of the Tax Assessment Act.

Section 109 did not prevent the superannuation fund from entering into related party transactions: it required that if the transaction was with a related party the transactions could not be favourable to the other party.  This means that the transaction could be favourable to the superannuation fund and unfavourable to the other party.  The ATO issued a short ruling in 2010 which confirmed this was the correct interpretation of s109.  The ruling (ATO ID 2010/162) confirmed that s109 was not breached if the terms of a related party loan were favourable to the superannuation fund – such as below market rates.  So far as the ruling goes – it is correct.  However, simply because one section does not apply does not mean that another section cannot apply.  The ATO did not mention or refer to s295-550 in the ruling.

With the release of the Contributions Ruling, Tax Ruling 2010/1, the ATO took the view that a below market interest rate loan or even a nil interest rate loan could not constitute a contribution to the superannuation fund.  However, if the loan to the superannuation fund was at say 6% and the lender forgave the interest repayments, then the amount forgiven would constitute a “deemed contribution”.  The distinction is that with a nil interest rate loan there is nothing payable by the superannuation fund but with a loan at 6% with the interest payment obligation forgiven, then a debt obligation of the superannuation fund has been released – so giving rise to an increase in value of the superannuation fund.  Consequently, the transfer of value to a superannuation fund by means of a favourable loan value could not be caught as a deemed contribution.

Section 295-550 provides that certain income of a superannuation fund (called non-arm’s length income (commonly abbreviated to “NALI”) which arises from various non-arm’s length transactions, is to be separately identified and taxed at 47%, even when the superannuation fund is in pension phase.

The ATO then informally but publicly confirmed in December 2012 the position that related party LRBAs at low or no interest rates cannot give rise to NALI income.

The ATO then publicly revised its position and stated that low or no interest rate limited recourse borrowing arrangements do in fact give rise to non-arm’s length income as the underlying transaction is not on arm’s length terms.  The public revision of its position occurred in December 2014 when new interpretative rulings were issued: ATO ID 2014/39 and ATO ID 2014/40.   These decisions were reissued in early 2015 as respectively ID 2015/27 and ID 2015/28.  The decisions were reissued to accommodate the introduction of the look through tax treatment of limited recourse borrowing arrangements but the substance was unaffected.