Key takeaways
- An SMSF can borrow from a related party, such as a member, under an LRBA.
- The loan must be on arm's length, commercial terms, not a sweetheart deal.
- The ATO publishes safe harbour terms that are taken to be arm's length.
- Non-commercial terms can make the fund's income non-arm's length income, taxed at the top rate.
It is possible for an SMSF to borrow from a related party rather than a bank, for example a member lending to their own fund. This can be convenient, but it carries a specific trap: the loan has to be genuinely commercial, or the fund can be hit with punitive tax.
The arm's length requirement
A related-party loan must be on the same terms a real lender would offer at arm's length. That covers the interest rate, the loan-to-value ratio, the loan term, repayment frequency, and security. A zero-interest or interest-free loan from a member, or terms no commercial lender would accept, is exactly what the rules are designed to catch.
The ATO safe harbour
To give trustees certainty, the ATO publishes safe harbour terms (in Practical Compliance Guideline PCG 2016/5). If a related-party loan meets those terms, including the published interest rate, maximum loan-to-value ratio and maximum term, the ATO accepts it is on arm's length terms. Meeting the safe harbour is the simplest way to stay on the right side of the rule. The current terms are on the ATO website.
Why getting it wrong is so costly
If a related-party loan is not on arm's length terms, the income the fund earns from the arrangement can become non-arm's length income (NALI). NALI is taxed at the top marginal rate rather than the concessional super rate, which can wipe out the benefit of holding the asset in super. The penalty is in the tax on the income, not just a slap on the wrist.
Document and maintain the loan
A related-party loan needs a proper written loan agreement, and the fund must actually make the repayments on the agreed schedule. A loan that exists only on paper, with no real repayments, will not survive scrutiny. Treat it exactly as you would a bank loan, because that is the standard it is held to.
Frequently asked questions
- Can I lend money to my own SMSF?
- Yes, a member can lend to their SMSF under a limited recourse borrowing arrangement, but the loan must be on arm's length, commercial terms. The simplest way to be sure is to meet the ATO's published safe harbour terms.
- What is the ATO safe harbour for related-party loans?
- It is a set of published terms (in PCG 2016/5), including an interest rate, maximum loan-to-value ratio and maximum term. A related-party loan that meets them is taken to be on arm's length terms, giving trustees certainty.
- What is non-arm's length income?
- Income earned from a non-commercial arrangement, such as a related-party loan on favourable terms. It is taxed at the top marginal rate instead of the concessional super rate, which can eliminate the benefit of holding the asset in super.
