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  • Holding trust

    The super law does not specify the type of trust that must be used as a holding trust in an LRBA. The law specifies only that the SMSF trustee must have a beneficial interest in the asset being held in the holding trust and the right to acquire legal ownership of that asset after making one or more payments. In addition, for the special in-house asset rule to apply, the asset must be the only property of the holding trust.

    More complex trusts are unlikely to satisfy the requirement that the SMSF trustee has the necessary interest in a particular asset of the holding trust. For example, a discretionary trust could not be used, nor could the SMSF trustee be one of a number of unit holders in a unit trust.

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    COVID-19 limited recourse borrowing arrangement relief

    We understand that temporary repayment relief may be offered in relation to an existing LRBA between an SMSF and a lender (which can be a related or unrelated party) due to the financial effects of COVID-19.

    This repayment relief may involve the lender accepting that loan repayments are deferred for a certain period. It might also require interest to be capitalised on the loan during the deferral period and allow for the loan to be extended to reflect the repayment relief. The variation in loan terms might also mean that the SMSF is no longer able to meet the safe harbour loan terms that we accept are consistent with an arm's length dealing.

    However if the varied terms arising from the repayment relief reflect similar terms to what commercial banks are currently offering for real estate investment loans as a result of COVID-19, we will accept the parties are dealing at arm’s length and the NALI provisions do not apply. We will also accept that these varied terms to the loan do not amount to a rescission or replacement of the original contract, or that there are fundamental changes to the character of the loan such that a new borrowing arises.

    The parties to the arrangement must also document the changes in terms to the loan agreement and the reasons why those terms have changed. It is also expected that there is evidence that interest continues to accrue on the loan and that the SMSF trustee will repay any deferred principal and interest repayments in accordance with the varied terms.

    Any further repayment relief needed due to the continued effects of COVID-19 should be reviewed at the end of the agreed deferral period and remain in line with what the commercial banks are offering at that time.

    Interaction with Division 7A and administrative relief for minimum yearly repayments

    As detailed above, to avoid an LRBA being subject to NALI the temporary repayment relief must be on similar terms to that offered by commercial banks. This relevantly includes that the unpaid interest must typically be capitalised on the loan.

    Where temporary repayment relief has been given with respect to an LRBA between an SMSF and a lender, and that loan is also a Division 7A loan, there will be no Division 7A consequences as a result of the interest being capitalised on the loan. However, interest that is capitalised does not count as a payment in determining if the minimum yearly repayment has been met for Division 7A purposes. 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 minimum yearly repayment by the relevant due date under the Division 7A rules.

    Whilst there is nothing preventing the capitalisation of interest on Division 7A loans under the Division 7A administrative relief, we understand that there is a view that interest cannot be capitalised on such loans given their Division 7A nature. Therefore, for the 2019-2020 and 2020-2021 income years, where an LRBA between an SMSF and a lender is subject to repayment relief but unpaid interest on the loan is not capitalised, we 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

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      Last modified: 25 Mar 2021QC 20439