Join Australia's most dynamic and respected property investment community

Related Party Loans - Terms

Discussion in 'Accounting & Tax' started by Paul@PFI, 22nd Apr, 2016.

  1. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

    Joined:
    18th Jun, 2015
    Posts:
    2,400
    Location:
    Sydney
    From time to time some property investors use a related party loan to finance some or all of their property. Examples include:
    - Spouse loans
    - Spouse to spouse refinancing for a change of ownership interest
    - Parent loans etc

    The general view given by posts on PC is that the loan must be documented (legal agreement) and other matters which place the loan on arms length terms. This is the concern...What are those terms ?? There really hasn't been any ATO guidance on what is acceptable. We know that a written agreement is required and that the loan must be maintained eg paid, accounted for etc

    A recent "determination" (Google PCG 2016/5) by the ATO in respect of SMSF loans provides a lot more guidance but is also not a definitive approach. Admittedly it is in respect of a SMSF arrangement but it should stand as a guide to best practice to avoid a dispute with the ATO later. The determination is guidance on what arms length loan terms "may" be. Its not a ruling or prescribed practice. Consider it a warning though.

    Here is what the ATO consider terms that are arms length for a SMSF that borrows from a non-bank lender :

    Interest Rate :
    Variable rate : Is to be based on published RBA Indicator Rate
    Fixed Rate : Chosen at commencement of loan based on indicator lending rate (Max 5 year term)

    Term : Maximum 15 years. Where a refinance occurs the original loan term is not to be extended.

    LVR : Max 70% for commercial and residential

    Security : A registered mortgage

    Guarantee : Not required

    Repayments : Minimum monthly as Principal and Interest. No interest Only loans.

    Agreement : A written and executed loan agreement is required

    Now remember this is guidance for a SMSF but from that it may be reasonable to apply similar guidance to a related party loan for any property. Matters specific to a SMSF that may vary for a non-SMSF loan may include:
    • Loan term...20-25 and even 30 years may be relevant
    • Repayments : Interest only. A term that exceeds normal bank lending rules (ie 5 years) may be a concern.
    • Absence of loan security. (? Is a second mortgage acceptable, A guarantee in the absence of this ? How is a related party guarantee considered ?)
    • Undocumented loans (A serious risk IMO)
    • Overseas lending - Concerns about exchange rate risks, enforcement and withholding tax
    Interesting that the ATO appears to adopt the view that arms length terms should mirror those of a bank lender. So that offers a degree of guidance that where you depart from this then a concern might arise. eg : Interest rate higher or lower than a lender may charge, lack of security, loan terms which dont repay the loan v's a bank which would expect the loan to be repaid etc The reference rate used for a related party loan probably should be based on a benchmark that is public. In that respect even a "mirrored loan" where the benchmark is the rate on the funds borrowed by the lender may well be sensible.

    What happens if my loan doesn't seem to comply with the above ? Nothing really, other than there is a higher risk that the ATO could find that the related loan is being maintained on non-arms length terms or that the loan is not on a arms length basis. Interest deductions could be denied or reduced. Part IVA anti-avoidance could even factor.

    Lesson in this ? Related party loans where interest deductions occur need to be soundly based and maintained.
     
  2. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    9,045
    Location:
    Sydney
    Good post Paul.

    I think anyone contemplating a related party loan should consider whether a private ruling is needed.
     
  3. S0805

    S0805 Well-Known Member

    Joined:
    3rd Jul, 2015
    Posts:
    333
    Location:
    VIC
    Paul, This is what I've always thought best way to arrange whenever we do it.....mimic what arrangements lender with the borrowing spouse which will take all the confusion of meeting standards or not....e.g. spouse A lends money to spouse B. Spouse A has loans with Lender A. Agreement between spouse A & B will mimic what arrangement A has with lender A. Any changes, interest rates, loan term, IO or PI will be same including future changes....
     
  4. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    9,045
    Location:
    Sydney
    What about security? Lender A will have a first mortgage.
     
  5. S0805

    S0805 Well-Known Member

    Joined:
    3rd Jul, 2015
    Posts:
    333
    Location:
    VIC
    Terry, does it require security? didn't thought of that :oops:

    Do we need to show that spouse A is better off with the deal....I mean then what's the point of related party loan....
     
  6. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    9,045
    Location:
    Sydney
    You have to consider would a commercial lender lend without security at the same rates as they lend with security?

    If not then do you consider this an issue the ATO could pick on.
     
  7. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

    Joined:
    18th Jun, 2015
    Posts:
    2,400
    Location:
    Sydney
    Generally a unsecured loan would have far shorter terms AND a higher rate. However that rate could result in a Part IVA concern where Mrs Smith (low income) borrows at 5% and lends to Mr Smith at 12% (high income + neg gearing) and both Mr & Mrs Smith engineer enhanced tax benefits.

    I would think this a perfect example of seeking a private ruling at the mirrored rate.
     
    S0805 likes this.
  8. Blacky

    Blacky Well-Known Member

    Joined:
    25th Jun, 2015
    Posts:
    1,105
    Location:
    Bali
    Paul
    What about in the event where the loan is not used as a deduction by either party.
    As an example if you lend money to a wholely owned subsiduary company. Nil interest is applied to the loan and in following years the loan is repaid?

    It is regularly used for a number of reasons, mostly where you can repay initial funds contributed. It also provides security for those funds (you become a secured lender).

    There is no tax impact to either party - though it does have other benifits.

    Blacky
     
  9. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    9,045
    Location:
    Sydney
    If there are no tax deductions claimed then nothing to worry about in claiming interest - just the other legal issues.
     
  10. Blacky

    Blacky Well-Known Member

    Joined:
    25th Jun, 2015
    Posts:
    1,105
    Location:
    Bali
    My concern was that the 'repayment' of the loan may be considered as income.

    Good to know.

    And yes - plenty of other potential legal issues to consider.

    Blacky
     
  11. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    9,045
    Location:
    Sydney
    not with a written loan agreement in place.
     
    Blacky likes this.
  12. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

    Joined:
    18th Jun, 2015
    Posts:
    2,400
    Location:
    Sydney
    Undocumented loans can result in the ATO arguing that the regular payments to the lender are assessable income AND non-deductible to the borrower. This approach is common for audit activity. Even if double taxation follows. The taxpayer has to fight it.
     
  13. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    9,045
    Location:
    Sydney
    There are so many people out there that doesn't realise they should be entering a written agreement with related parties - 'but is my company/trust' they say.
     
  14. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

    Joined:
    18th Jun, 2015
    Posts:
    2,400
    Location:
    Sydney
    I am the company. Its my trust money. Or they just operate a bank account in their own name. One of the best is when they never open a trust bank account. To save $13 a month.

    A trust without assets ? The deposit, duty and settlement paid using offset money. No loan agreement. No bank account.
    Q : Is there a trust ? Maybe not. No loan. No interest. Maybe a title problem and a OSR enquiry. Duty ?

    Seen it before.