The safe harbour provisions interest rate is the RBA’s indicator lending rate for banks providing standard variable housing loans for investors. This is given by the RBA’s interest rate series FILRHLBVSI. It is an average across a collection of banks of the interest rate in variable interest rate loans on housing for investors. By definition, therefore, it is worse than some commercially available loans. Examples of commercial loans that offer better terms than the other arm’s length dealing terms are easy to find (e.g. loan to value ratio or fixed interest period). Such an LRBA taken with parties who are not at arm’s length offers no guarantee than the generated income will be arm’s length income.
Suppose that an investor wishes to take a loan from someone who is not at arm’s length and has the option to hold any resulting assets personally or in an SMSF. In order to avoid producing non-arm’s length income (NALI) the SMSF will use the safe harbour provisions, but if held personally better terms for the loan could be available.
It is possible to calculate the interest rate on the loan for a personally held asset that will ensure the same cashflows, and hence the same rate of return, as holding the asset in the SMSF. For example,
if the loan is taken for $300,000 and the asset produces an income of $30,000 then the equivalent interest rate of the loan is 3.34%. As the asset produces more income relative to the outstanding amount of the loan the equivalent interest rate will decrease, eventually reaching rates that will be difficult to justify to the ATO. Conversely, a lower income will increase the equivalent interest rate making it easier to justify holding assets personally.
This is an idealised situation as, for example, an SMSF only has access to principal and interest loans under the safe harbour provisions. Never-the-less it informs us that the the safe harbour interest rate maybe comparable to the best commercial rates if the asset is held personally.
There are many interrelated factors that determine the final rate of return of an investment. Approaches to investment that do not take into account the effects of one factor on another may not give the best rate of return. Worse, they may be unable to accurately determine the effect on the rate of return of changes in investment conditions. In the example above, it is the interplay between tax rates, loan interest rates and the level of negative gearing that allow the safe harbour interest rate to compare favourably.
For $440 NetActuary will provide a report which will calculate expected rates of return for different holding structures, different loan types and under variations in investment conditions for property investment. Our software is capable of a great deal of flexibility, but in the unlikely situation that the report is not suitable we can provide custom calculations to provide investors with the information needed to make an informed decision.
Dr. Ben Whale