SMSF related-party loans: the ATO safe-harbour terms (PCG 2016/5) explained

An SMSF can borrow from a related party — typically a member or their family company — to fund a property purchase under a limited recourse borrowing arrangement (LRBA). The risk is non-arm's-length income (NALI): if the loan terms are more favourable than a commercial lender would offer, all income from the asset (including the eventual capital gain) is taxed at 45% instead of 15%. The ATO publishes safe-harbour terms in Practical Compliance Guideline PCG 2016/5 that, if followed exactly, are deemed arm's-length.

What is NALI and why does it matter?

Section 295-550 of the ITAA 1997 treats income from non-arm's-length dealings as NALI, taxed at the top marginal rate of 45%. For an LRBA, a related-party loan at 1% interest, 100% LVR or interest-only forever would all be considered non-commercial — turning what should be 15%-taxed rental income into 45%-taxed NALI. The capital gain on eventual sale is also NALI. The dollar consequences can easily exceed the benefit of the cheap loan.

PCG 2016/5 safe-harbour terms for 2025–26

If the loan meets every one of the following terms, the ATO will not apply NALI to the LRBA. For real property loans entered into or refinanced during 2025–26:

• Interest rate — the RBA indicator lending rate for banks providing standard variable housing loans for investors, published in May for the following financial year (8.95% for 2025–26 for real property)
• Fixed or variable — may be fixed for up to 5 years if fixed at the time of drawdown
• Loan term — maximum 15 years for real property; 7 years for listed shares or units
• Loan-to-value ratio (LVR) — maximum 70% for real property; 50% for listed shares or units
• Security — a registered mortgage over the asset held in the bare trust
• Personal guarantees — permitted from members but not required
• Repayments — monthly, principal and interest
• Written loan agreement — executed before drawdown, with all the above terms documented

Listed share LRBAs are different

Safe-harbour terms for listed shares and units are stricter: maximum 7-year term, maximum 50% LVR, and a higher published interest rate. Most related-party share LRBAs we see fail the term test because the loan was structured at the property-loan defaults. If the underlying asset is a marketable security, use the share-specific terms.

What if you don't meet safe-harbour?

You are not automatically caught by NALI — you just lose the certainty PCG 2016/5 provides. You then have to demonstrate the terms are otherwise arm's-length, which usually means obtaining a written commercial loan quote from a third-party lender at the same time, for the same asset, on the same terms. This is harder than it sounds in practice — banks rarely quote LRBAs for non-customers — so most trustees structure to fit inside safe-harbour.

Documentation the auditor will ask for

• Signed loan agreement dated before the drawdown
• Registered mortgage (or equivalent security) over the bare trust property
• Bank statements showing each monthly P&I repayment from the SMSF to the lender
• Annual statement of loan balance
• Calculation showing the interest rate matches the PCG rate for the year
• Trustee minutes approving the loan and confirming reliance on PCG 2016/5

Common failures

The most common related-party LRBA failures we see in audit: interest rate not updated when the PCG rate changes each year (rate is fixed at drawdown if you elect the fixed option, but variable loans must move with the published rate); interest-only repayments past the permitted period; loan term written as 25 years; LVR drifting above 70% because the property value fell. Any of these will trigger the auditor to consider NALI for the year.

Sources: Australian Taxation Office — Practical Compliance Guideline PCG 2016/5; Income Tax Assessment Act 1997, section 295-550; Superannuation Industry (Supervision) Act 1993, sections 67A and 67B.