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Related Party Loans

Considerations and Options

For many people with a SMSF, or looking to form a SMSF, the opportunity to allow the SMSF to borrow from the Members of the Fund and leverage into property with slightly more cost effective structures is appealing.

For many people the option to make a loan to the Fund, as opposed to an un-deducted contribution, is a useful way to make large sums available to the SMSF quickly and with a greater degree of flexibility.

Likewise, related party lending can allow a SMSF to borrow at higher Loan to Value Ratios (LVR) and lower interest rates.  The latter was particularly true for the first year or so after the SIS Act was amended ~ however for many the "urban myth" that third-party (i.e. bank) loans to SMSF's are at significantly higher rates persists.

Regardless of whether you choose to use a third-party loan, a related party loan, or a combination of both ~ you will be well served by using the services of a SMSF Loans specialist who can ensure that your scenario is presented to prospective lenders in the best light and assist your advice Team to structure the transaction in an efficient, timely and compliant manner.

Below are some considerations that we believe ought to be taken into account when deciding whether to use a related party loan and, if so, how best to utilise available assets to maximise opportunities going forward.  Sadly, it has been our experience that few SMSF Trustees or their Advisers are taking all relevant considerations into account.

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General Advice Warning:  Nothing on this page constitutes financial advice nor is it a specific recommendation.  Your personal situation has not been taken into account and you must seek your own legal, financial and taxation advice in determining what loan structures are best for your unique circumstances and goals.

Options

When looking to utilise a related party loan people will normally fall into two broad categories:

  • They have sufficient 'cash' reserves outside Superannuation to simply loan the SMSF the amount necessary to undertake the property purchase.
  • They have sufficient equity in real property held outside Superannuation to allow them to take a third party loan and 'on-lend' those funds to the SMSF.
In either of the above cases, the Trustee of the SMSF then has the option of:
  • Simply utilising the related party loan and other cash assets of the SMSF to complete the property transaction, or
  • Gaining further leverage for the SMSF by utilising the related party loan as 'deposit' funds and taking a third party SMSF loan for the balance of the property purchase price.

The following table outlines some of the advantages and considerations of the various permutations available for related party loans to your SMSF.

Scenario Advantages Considerations
Lending the full property purchase price to the SMSF from cash resources available outside Super
  • Simplified SMSF loan documentation
  • Avoids 3rd party lender approval and review processes
  • May result in a lower interest rate being charged to the SMSF ~ however see ATO Concerns below
  • Ensure loan documentation is prepared by a professional and is compliant
  • Opportunity cost of using the 'cash' outside Super
  • No leverage gained inside or outside Super
  • Under current legislation the only time the SMSF can leverage the property is at the time of acquisition.
  • There is no scope for subsequent 'equity release'
Borrowing the full property purchase price against equity outside Super with a simultaneous related party loan to the SMSF
  • Simplified SMSF loan documentation
  • Minimises 3rd party lender approval and review processes to 'conventional' loan outside Super
  • May result in a lower interest rate being charged to the SMSF ~ however see ATO Concerns below
  • Ensure loan documentation is prepared by a professional and is compliant
  • Opportunity cost of using the available equity outside Super
  • The nett leverage gained by the SMSF is only that derived from the loan 'external' to the Fund
  • Have a SMSF Loans specialist assist with the loan outside Super in order to assist the lender with an understanding of the transaction
  • Under current legislation the only time the SMSF can leverage the property is at the time of acquisition.
  • There is no scope for subsequent 'equity release'
Lending part of the property purchase price to the SMSF from cash resources held outside Super with the balance of the money coming from assets already held in the SMSF
  • Simplified SMSF loan documentation
  • Avoids 3rd party lender approval and review processes
  • May result in a lower interest rate being charged to the SMSF ~ however see ATO Concerns below
  • Ensure loan documentation is prepared by a professional and is compliant
  • Opportunity cost of using the 'cash' outside Super
  • No leverage gained inside or outside Super
  • Under current legislation the only time the SMSF can leverage the property is at the time of acquisition.
  • There is no scope for subsequent 'equity release'
  • Ties up significant 'cash' resources of the SMSF
Lending part of the property purchase price to the SMSF using funds borrowed against equity outside Super with the balance of the money coming from assets already held in the SMSF
  • Simplified SMSF loan documentation
  • Minimises 3rd party lender approval and review processes to 'conventional' loan outside Super
  • May result in a lower interest rate being charged to the SMSF ~ however see ATO Concerns below
  • Ensure loan documentation is prepared by a professional and is compliant
  • Opportunity cost of using the available equity outside Super
  • The nett leverage gained by the SMSF is only that derived from the loan 'external' to the Fund
  • Have a SMSF Loans specialist assist with the loan outside Super in order to assist the lender with an understanding of the transaction
  • Under current legislation the only time the SMSF can leverage the property is at the time of acquisition.
  • There is no scope for subsequent 'equity release'
Lending part of the property purchase price to the SMSF from cash resources held outside Super with the balance of the money coming from a 3rd party loan to the SMSF
  • Achieves significantly greater leverage with regards to the Fund's property asset
  • Allows other assets of the Fund to be invested elsewhere (diversified)
  • Can allow the Fund to acquire a more valuable leveraged property portfolio
  • Ensure loan documentation is prepared by a professional and is compliant
  • Opportunity cost of using the 'cash' outside Super
  • SMSF will need to demonstrate the ability to service both the related party loan and the 3rd party loan
  • Ensure this level of leverage is in accordance with the Fund's investment strategy
Lending part of the property purchase price to the SMSF using funds borrowed against equity outside Super with the balance of the money coming from a 3rd party loan to the SMSF
  • Achieves the highest level of leverage. 100% of the purchase price can be provided by loans
  • Allows other assets of the Fund to be invested elsewhere (diversified)
  • Can allow the Fund to acquire a more valuable leveraged property portfolio
  • Ensure loan documentation is prepared by a professional and is compliant
  • Opportunity cost of using the available equity outside Super
  • SMSF will need to demonstrate the ability to service both the related party loan and the 3rd party loan
  • Ensure this level of leverage is in accordance with the Fund's investment strategy

 

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ATO Concerns

Regardless of where the money for a related party loan has been sourced from, it is important that you can demonstrate that you are charging a commercial or 'arms-length' rate of interest to your fund.  Some points to note are:

  • If you charge too high a rate of interest the structure could be viewed as an "early access scheme" or otherwise breach the sole purpose test through providing a 'non-retirement' benefit to the Members.  In any event, you will create a tax liability in your own name.
  • If you charge too low a rate of interest it could be determined that you have given a benefit to the SMSF, effectively in the form of a contribution.  (Recent comments by the ATO would suggest that this is not as great a concern as charging too much interest)
  • If raising money by taking a loan against equity held outside Super it would seem simple enough to on-lend at the same interest rate as that being charged by the third-party lender.  While this may be acceptable to the ATO, be aware that the third-party loan will be a full recourse loan whereas the loan you make to the SMSF will be a limited recourse loan.  Therefore, normal commercial considerations may dictate that the loan to the SMSF should be at a higher rate ~ using a normal "rate for risk" approach.

 

 
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