Self-managed super funds that borrowed from a private company under a limited recourse borrowing arrangement (LRBA) will not suffer adverse tax consequences if the loan interest has been capitalised because of COVID-19.
This recent announcement by the Australian Tax Office was welcomed by the SMSF Association.
SMSFA deputy chief executive and director of policy and education Peter Burgess said the option of capitalising interest in circumstances where the SMSF would be eligible for loan repayment relief under COVID-19 relief measures will not cause the loan to be treated as a deemed unfranked dividend. The relevant income will not be taxed as non-arm's length income either.
About 10% of SMSFs have LRBAs, the majority of which use the debt to acquire property.
"We had previously highlighted an inconsistency between the requirements that must be satisfied under Division 7A of the ITAA 1936 for the loan not to be treated as a deemed dividend and the requirements of the ATO's safe harbour provisions for the relevant income received by the fund not to be taxed as non-arm's length income," he said.
While safe-harbour terms and associated COVID-19 relief measures permit the capitalisation of loan interest, it was unclear whether this would breach Division 7A and result in the SMSF having to treat the loan as a deemed unfranked dividend, which would then have adverse tax implications for the fund.
"The ATO has now confirmed, that assuming all other conditions are satisfied, this will not be the case," Burgess said.
Speaking at the recent SMSFA National Conference, Burgess reminded delegates that taxpayers must apply for administrative relief if they are unable to make the minimum yearly repayments on their Division 7A loans by the end of the lender's 2019-20 income year.