ATO backflip on zero interest loans

The Tax Office made a surprise ruling in 2012, but now it has changed its mind.

Summary: Two years ago, the Tax Office responded to industry concerns over the treatment of zero interest loans, primarily made by trustees, to self-managed super funds. At the time, it ruled that such loans were entirely legal. But now, in a private ruling, it seems the ATO has changed its mind and is cracking down on some SMSF loan rorters.
Key take-out: The ATO private ruling, using a declared a set of facts, has found that one SMSF has pushed the envelope in relation to being loaned funds at zero interest. It was alleged by the ATO that wealthy Australians are using this lending rule to get around the strict superannuation contribution laws.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Self-managed super funds have again been tarnished with the “rorters” brush – this time on zero interest loans to their super funds.

A private ruling, followed by some public comments from the Australian Tax Office in regards to the practices of some funds, has led to the conclusion in some media reports that those funds whose practices have been highlighted are involved in tax minimisation and deserve punishment.

The ATO is going to “crack down” on this area that, it is suggested, is a “loophole”. Some will always attempt to rort the system, won’t they?

No, it’s not a loophole. It’s a door the ATO, to the shock of the industry, opened 18 months back. But sure, yes, some people will try to push it too far and that’s probably what’s happened on this occasion.

In essence, the concern is this: SMSF trustees are lending money to their SMSFs, but charging a 0% interest rate. This means that the SMSF isn’t having to pay out interest, thereby retaining more money in the low-tax environment that is super and not paying tax outside.

The allegation was that this is a “well known” strategy in SMSF circles that allows wealthy Australians to get around the strict contribution laws, which limit members to contributing no more than $35,000 a year (less if you’re below 60 years old) in concessional contributions and $150,000 in non-concessional contributions. If they are already maxing out on those limits, then having a 0% interest loan in place are they effectively making de-facto contributions beyond those limits?

Clarifying a grey area

A few years ago, the SMSF industry was so concerned that legislation did not specifically address this point, and was a grey area, that it went straight to the ATO and asked it to provide some guidance.

In December 2012, the ATO provided that guidance, via the high-powered National Tax Liaison Group. The ATO’s answer wasn’t wishy washy. It was surprisingly frank.

First, the ATO was asked if it would count as a contribution if a low (not zero, but low) interest rate was charged by the lender (the individual as trustee). The ATO’s answer was “no”, unless the interest was actually paid by another party.

Then the following question was asked:

“Can an SMSF enter into a borrowing arrangement ... with a related party [the individual, or a related entity] if a zero rate of interest is charged by the related party lender and only principal repayments, with no imputed interest, are made throughout the loan term in accordance with the loan agreement?”

And the ATO’s response was very clear:

“Yes. A lower than market interest rate or the absence of a requirement to pay interest on money loaned to the trustee by a related party will not prevent the arrangement from being a borrowing for the purposes of section 67A of the (Superannuation Industry Supervision Act). The ATO recognises that while the obligation to pay interest may evidence the existence of a borrowing of money, it is not a necessary feature of such a borrowing.”

The ATO went on to suggest it would be more concerned if the SMSF paid an interest rate to the related party that was higher than they could get commercially (currently, say, 5-7%). This is more obvious, as it would more clearly be the individual receiving an immediate benefit from their super, which is banned under the sole purpose test requirements.

The ATO’s answer was clear. Few involved in the NTLG had expected it. In fact, they had expected the opposite, which is why they had asked.

Private ruling changes the landscape

But a private binding ruling from the ATO in April has set a cat amongst the pigeons.

In that ruling – private rulings are always based on a determined set of facts – the ATO ruled that it would instead tax the SMSF’s income at 45%.

In that case, the SMSF had been loaned, by a related party, a large sum of money with a 0% interest rate with a loan term that was apparently unclear, but arguably decades, to buy shares.

Some media claimed it was “well known” rort that was specifically designed to get around contribution limits. Well, no, it wasn’t.

Prior to the NTLG meeting, it had no doubt been raised by some who were keen to push the envelope. But the guidance given by the ATO at that NTLG meeting essentially unlocked a door that many thought had six-foot thick concrete stopping that from happening.

If rules have some stretch around them, people will always seek to see how much elasticity is in that rubber.

On this occasion, a private binding ruling has declared a set of facts that the ATO believes have gone too far. It may decide other sets of facts placed before do not push the envelope.

Those opportunities are lining up. Some industry figures say there are 20-30 other requests for private binding rulings in with the ATO.

If the ATO has changed its mind on an issue, SMSFs should not be branded rorters. If it is one set of facts that it has “gone too far”, then it should be seen for what that is.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking, plus four titles on property investment, including Property Investing For Dummies (John Wiley & Sons, 2013). E:
Graph for ATO backflip on zero interest loans

  • SMSFs are “grossly underweight” in bonds and need to be exposed to the asset class to diversify their portfolios and protect themselves from market volatility, according to Credit Suisse. The investment bank says cash is a poor replacement for bonds because bonds returns are negatively correlated with equities, which balances portfolio returns during bear markets.
  • The Australian Taxation office (ATO) says it will review the contravention reporting thresholds for SMSFs because of the changes in the sector since they were introduced, including the introduction of the penalty regime. If new standards are created, the ATO says they will most likely take effect by July next year.

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