The release of the much awaited interpretative decisions, ATOID 2014/39 and ATOID 2014/40 regarding non-commercial limited recourse borrowing arrangements, has provided important insights into the key elements of what the Commissioner views as non-arm’s length income (NALI) for the purposes of section 295-550 of the Income Tax Assessment Act 1997 (ITAA 1997). Following the release of these public rulings, the Australian Taxation Office (ATO) has also updated its website outlining the important considerations that would constitute such an arrangement being non-commercial for the NALI provisions.
It is important to note that the facts of each case with ultimately determine whether a particular LRBA arrangement is non-commercial and would give rise to NALI. The ATO has indicated the greater scrutiny will be applied to related-party LRBAs where the terms of the loan, taken together, and the the ongoing operation of the loan, are not consistent with what an arm’s length lender dealing at arm’s length would accept in relation to the particular borrowing by the fund trustee.
What needs to be considered?
The ATO has indicated that items such as:
- the nature of the acquirable asset
- amount borrowed
- term of the loan
- loan-to-value ratio
- interest rate charged (or other means by which the lender is compensated for the opportunity costs in lending the principal)
- regularity and frequency of principal repayments required
- security taken for the borrower’s performance under the loan, given the limited recourse nature of the loan (e.g. mortgages and guarantees by fund members)
- extent to which the loan has operated in accordance with its terms
are all likely to be considered in determining the nature of dealings being at arm’s length for the purposes of the NALI provisions.
The onus remains on the trustee to be able to demonstrate that the arrangement is consistent with what an arm’s length lender would accept in relation to a particular borrowing undertaken by the fund trustee. From the decisions within ATOID 2014/39 and ATOID 2014/40, the Commissioner has indicated that the terms of the loan, taken together, and the ongoing operation of the loan are clearly not consistent with what a ‘commercial’ lender would provide.
As a result, the outcome of the arrangement if the parties were dealing at arm’s length would have been:
- No income, as the lender would not have entered into the arrangement on these terms; or
- A lesser amount of income, as the lender would have provided terms (e.g. LVR) at a lesser rate, influencing the income the fund would have ordinarily derived.
On this basis, the view is now that section 295-550 of the ITAA 1997 applies and the income derived in respect to the investment will be taxed at the non-arm’s length income rate of 47%.