Newsletter No. 10, October 2013

Zero per cent interest loans

I have been in two minds as to whether to write this month’s article on “zero per cent interest loans”.  This topic was often raised and discussed with clients throughout my time as a Technical Adviser and Senior Compliance Officer in the Australian Taxation Office (ATO).  Since leaving the ATO, I have been asked this question over and over again, so I thought it best to explain the wording of the superannuation legislation and let Self Managed Superannuation Fund (SMSF) trustees make up their own minds on whether to provide interest-free loans to their SMSFs under a limited recourse borrowing arrangement.

Let’s start with the wording of the superannuation legislation.  Section 109 of the Superannuation Industry (Supervision) Act 1993 (SISA) provides that a trustee must not invest unless:

  •  the parties are dealing on arm’s length terms or
  • the parties are not dealing at arm’s length terms but the terms and conditions of the transaction are no more favourable to the other party than if the parties were dealing at arm’s length.

I have put emphasis on the words “other party” because what the legislation is stating is where the trustee of an SMSF borrows from a related party (e.g. members of the SMSF) on terms that are not arm’s length but are no more favourable to the other party (i.e. the members), the trustee will not contravene the law.  So if the trustee of an SMSF enters into a low or no interest loan with the members of the SMSF to purchase an asset under the limited recourse borrowing arrangement, it would not contravene the arms’ length provisions under the SISA.

To further demonstrate how this area of the law is interpreted by the ATO, you may wish to read the ATO publication ATOID 2010/162.  In this document, the ATO considered the question: “Does a trustee contravene section 109 of the SISA if it borrows money from a related party of the SMSF under a limited recourse borrowing arrangement on terms favourable to the SMSF?”  The ATO responded with “No.  The terms cannot be more favourable to the related party than would have been the case had the parties been dealing at arm’s length, but there is no contravention of section 109 if the terms are more favourable to the SMSF.”  What this means is the ATO only views a loan as a SISA arm’s length contravention if the terms of the loan favours the lender (i.e. the related party).

Now, I am unsure why the arm’s length provision is written like this.  It is my opinion that it may be a loop hole that should not have been interpreted in this way.  To me, trustees of SMSFs should always deal on commercial terms like those offered by a bank for example. All I can suggest is if you are thinking of lending your money to your SMSF so that your SMSF can purchase an asset under the limited recourse borrowing arrangement, perhaps get confirmation from the ATO that an interest-free loan arrangement is allowable.

Having worked for the ATO for the past 28 years, I am aware of many situations where transactions that were previously allowed were no longer allowed at a later date.  A good recent example of this is where prior to 2013, the ATO did not allow tax exemptions on death benefit pensions paid to dependants after the member’s death.  Another example is where vacant land was not considered a business real property and the ATO then later changed its position.  Also keep in mind that although the ATO stated interest-free loans do not contravene the SISA, it did not spell out whether it contravenes any other law such as the Income Tax Assessment Act 1997. I personally would not risk a zero per cent interest loan because loop holes do have a way of closing.

Disclaimer

Monica Rule is the author of “The Self Managed Super Handbook – Superannuation Law for Self Managed Superannuation Funds in plain English”.  Her advice is general in nature and readers should seek their own professional advice before making any financial decisions.