SMSF Loan Agreements

Where a fund acquires an asset under a limited recourse borrowing arrangement, the loan must itself satisfy the conditions that make the borrowing permissible. The lender may be a bank or a related party, and the documentation differs accordingly.

What the loan has to do

• Be limited in recourse. The lender's rights on default must be confined to the acquired asset. Recourse to the fund's other assets defeats the exception entirely.
• Relate to a single acquirable asset, consistent with the holding trust.
• Be capable of repayment from the fund, which means the terms have to work against the fund's actual cash flow.
• Be properly evidenced, with the borrower correctly identified and the security matching the structure.

Related party loans

A member or a related entity may lend to the fund, and it is a common way to fund an acquisition without a bank. The risk is that a loan on terms more generous than commercial ones can be treated as conferring a benefit on the fund, with consequences that are considerably worse than the interest saved.

The Commissioner has published safe harbour terms covering matters such as the interest rate, the loan to value ratio, the maximum term, the repayment basis and the security required. A loan documented and administered within those terms is treated as being on arm's length terms. A loan outside them is not automatically fatal, but the fund then carries the burden of showing the terms are commercial.

The two practical points are that the safe harbour figures are updated, so the rate applying to a loan must be checked against the year rather than assumed, and that the terms have to be followed. Repayments actually made, interest actually charged, and records actually kept are what make the document worth having.

What we prepare

• The loan agreement, drafted as limited recourse and matched to the holding trust.
• The mortgage or security documents, and their registration.
• Trustee resolutions for the fund and the holding trustee.
• Review of a bank's documents where the fund is borrowing commercially, to confirm the recourse limitation is genuine.

This page is general information. It is not legal, tax or financial advice. The safe harbour terms change, so the current year's terms should be confirmed.