As discussed here, as part of the ATO COVID-19 administrative concessions, the ATO announced that temporary repayment relief could be offered for limited recourse borrowing arrangements (LRBA) loans. The repayment relief must reflect similar terms to what commercial banks offered for real estate investments loans as a result of COVID-19. These terms include temporary repayment deferrals for most business of up to 6 months (with the possibility of a further 4 month extension), with unpaid interest being capitalised on the loan. The ATO confirmed that where such repayment relief is offered under a LRBA, as long as the relief reflects similar terms to what commercial banks are offering, the ATO will accept the parties are dealing at arm’s length and the non-arm’s length income (NALI) provisions do not apply.

Some LRBA loans will also be Division 7A loans for the purposes of Division 7A of the Part III of the Income Tax Assessment Act 1936, due to the lender being a related company, or a related trust that has an unpaid present entitlement owing to a company (directly or through a chain of trusts). Where Division 7A is triggered, the loan will be treated as an unfranked dividend to the SMSF, and potentially deemed to be a contribution.

One of the requirements for a Division 7A loan is that the borrower must make a minimum yearly repayment (MYR) by the end of the private company’s income year. This avoids the borrower being considered to have received an unfranked dividend, generally equal to the amount of any MYR shortfall. In response to the financial impact of COVID-19, the ATO allowed an extension of the repayment period for those borrowers who could not make their MYR by the end of the lender’s 2019-2020 income year.

While the LRBA COVID relief expressly allows for interest to be deferred for 6-10 months, with the interest being capitalised on the loan, the position for the Division 7A relief was not clear. The initial ATO website material in relation to the Division 7A relief appeared to not allow for interest to be deferred. Rather, it indicated interest must be continue to be paid, albeit at the lower Division 7A rate, and the balance of the interest could potentially be deferred.

The ATO has now clarified that:

• For LRBAs with Division 7A loans that have used the temporary repayment relief, there will be no Division 7A consequences as a result of interest being capitalised on the loan;

• Interest that is capitalised does not count as payment in determining if the MYR has been met;

• Therefore, to avoid the unpaid amounts being taxed as unfranked dividends, SMSFs in this position can apply for Division 7A administrative relief if they are unable to make the MYR by the relevant due date.

Importantly, the ATO has confirmed that given the previous confusion around capitalisation of interest, they will apply a transitional compliance approach. For the 2019-2020 and 2020-2021 income years, where interest has not been capitalised under an LRBA subject to repayment relief, they will not take compliance action to determine if the NALI provisions apply, provided that:

• The LRBA is also subject to a complying loan agreement (for Division 7A purposes), and

• The SMSF has met their minimum yearly repayment or has applied for Division 7A administrative relief where they have been unable to meet the minimum yearly repayment, and

• The temporary repayment relief is due to the financial effects of COVID-19 on the SMSF, and

• The repayment relief is otherwise on similar terms to that offered by commercial banks.

To discuss or for further information please contact:

Phil Broderick
Principal
M +61 419 512 801 | T +61 3 9611 0163  
E: pbroderick@sladen.com.au           

Philippa Briglia
Senior Associate
T +61 3 9611 0173
E pbriglia@sladen.com.au