A related party loan is where the Members of an SMSF act as the Bank towards the Fund. They will lend money to the SMSF instead of a Bank. A line of credit mortgage can be used for Members to obtain the Loan in their personal capacity and then on-lend the money to the SMSF. The typical structure is set out below:
The structure for the related party loan can be more cost effective because there is no legislative requirement to set up a Corporate Trustee and a Custodian Trustee. The related party loan can be simply held by the Bare Trust/Custodian Trust with Individual Trustees. Unlike a related party loan, if the SMSF intends to buy properties with bank loans, a Corporate Trustee and a Custodian Trustee are required to be set up by most Banks.
When we set up the related party loan structure for your SMSF, we will provide you with all the necessary documentation and also a loan schedule showing the loan details and the monthly repayment.
Arm’s Length & Commercial Terms
It’s important to ensure the terms of lending to the SMSF are on an arms-length basis and issued on commercial terms. This means the Members need to charge a reasonable amount of interests on the loan to the SMSF. There is a school of thought that argues zero % interest related party loans is acceptable, however we believe this could put the Fund in risk as the transactions are not on an arm’s length basis.
Safe Harbour Provisions
The Tax Office has recently published a practical compliance guidance (PCG 2016/5) which sets out the recommended interest rate and the loan terms (called ‘safe harbour’ terms) for a related party loan. For SMSF Trustees with Limited Recourse borrowing arrangements (LRBAs) which do not meet the ‘safe harbour’ terms in the practical compliance guidance 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 practical compliance guidelines. 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. Please note a sample loan repayment schedule here:
An SMSF cannot lend money to a related party
Although the Members of an SMSF can lend money to their Super Fund, the SMSF cannot give a loan to a related party. It is regarded as providing financial assistance to Members and breaches the Sole Purpose Test. Please see the ATO video below for more information:
SMSF Loans & Early Access
For details on the structure to be set up for the Bank Loan, please refer to this page.