Limited Recourse Borrowing Arrangements - gearing of SMSF s Can a SMSF borrow money? On and from 24 September 2007, the Superannuation Industry (Supervision) Act 1993 (SIS) was changed to permit a SMSF to borrow to acquire an asset by the introduction of section 67(4A) of SIS (the old rules). The SIS rules were changed again for borrowing arrangements entered on and from 7 July 2010 (the new rules) by replacing section 67(4A) with sections 67A and 67B. The ATO has now finalised its ruling SMSFR 2012/1 about its interpretation of the new rules, including what is a single acquirable asset, what are expenses connected with the borrowing or acquisition and what is maintaining or repairing the asset but not improving it. The ATO also has a Q&A publication about the old rules and the new rules (Q&A) - see: http://www.ato.gov.au/super/self-managedsuper-funds/in-detail/assets-andinvestments/limited-recourse-borrowingarrangements-by-self-managed-super-funds--- questions-and-answers/ A SMSF borrowing is nothing more than a loan to the SMSF with strict conditions that must be met. Sections 67A and 67B permit the borrowing. Section 71(8) ensures that there will be no breach of the in house asset rules because of the trust relationship that arises when the asset is purchased and held on trust. The new rules no longer refer to instalment warrants. Previously, the only reference to it was in the heading to the prior section 67(4A). While the new rules and market place refer to a SMSF s right to borrow as a limited recourse borrowing arrangement (LRBA), the borrowing rules are a traditional instalment warrant as: there is an arrangement for the SMSF to acquire an asset the arrangement involves an initial payment by the SMSF and a loan to it until the loan has been paid in full, the SMSF only has a beneficial interest in the asset on repayment of the loan, the SMSF can acquire legal title to the asset the lender s only recovery right against the SMSF is limited to the SMSF s interest in the asset What are the strict conditions for a SMSF to borrow under a LRBA? The strict conditions that must be met are: the loan must be used to acquire a single acquirable asset including borrowing or acquisition expenses, expenses in repairing or maintaining but not improving an asset SIS must otherwise allow the SMSF to buy and own that type of asset the asset must be held on trust for the SMSF (and the trustee is normally called a custodian) so that the SMSF receives a beneficial interest in it the SMSF must have the right (but not the obligation) to acquire legal title of the asset by making one or more payments the rights of the lender (and any third party security provider for the SMSF borrowing) against the SMSF on default under the loan and/or security must be limited recourse (that is, the recovery rights against the SMSF must be limited to the SMSF s interest in the acquired asset) KNOWLEDGE + INNOVATION + SKILL = SOLUTIONS Level 16 55 Clarence Street Sydney NSW 2000 GPO Box 7082 Sydney NSW 2001 T 02 8915 4900 F 02 9290 2998 E mail@sydneybl.com.au Liability limited by a Scheme approved under Professional Standards Legislation. Legal Practitioners employed by and directors of Sydney Business Lawyers Pty Ltd are members of the Scheme.
Limited Recourse Borrowing Arrangements - gearing of SMSF s So how do LRBA s work? An LRBA works like this: a party lends money to a SMSF to purchase an asset under a normal loan agreement the loan can be from a related party or an unrelated third party, such as a bank the asset is held on trust by a custodian until the loan is repaid and so, a trust document will be required the SMSF will normally contribute to the purchase price from its own funds but it does not have to the lender s LVR requirements are met the lender s loan and security documentation must limit the lender s rights to recover its loan to the SMSF s interest in the purchased asset (although, security is not required to meet the LRBA requirements) the loan terms and conditions should always reflect the market (ie be on arm s length terms) or certainly be no more favourable to the lender than had the parties been dealing at arm s length in the case of a related party loan, it is best practice to have market evidence to support the loan conditions to make sure the lender receives no more favourable terms than if the lender had been at arm s length Are there any AFSL requirements? At present there are no AFSL requirements attached to an LRBA (by law). The Federal Government has made noises about introducing new laws that make LRBA s a financial product. If that happens, as the LRBA will be a financial product, the entry of a LRBA will be regulated by the financial services laws in Part 7.9 of the Corporations Act 2001. This means that the LRBA will be required to be issued by a party that holds an Australian Financial Services Licence (AFSL). The holder of the AFSL will need to issue a statement of advice (SOA). A Product Disclosure Statement (PDS) will also be required. Until these new laws happen, in entering a LRBA, none of an AFSL, SOA or PDS are required by law, although, some lender s insist on a SOA with the associated costs that come with it. What can the borrowing be used to do? Under section 67A(1)(a), the money borrowed: MUST BE applied to the acquisition of single acquirable asset So the SMSF trustee cannot borrow and secure the borrowing over an existing SMSF asset. MAY BE spent on expenses incurred in: connection with the borrowing or acquisition; or maintaining or repairing the acquirable asset but not improving it. An acquirable asset is any asset other than money that a SMSF trustee is not prohibited from acquiring under SIS (see paragraph 6 of SMSFR 2012/1). Section 10(1) of SIS defines an asset to mean any form of property. Can a LRBA be used for an existing asset? The ATO s very clear view is that the LRBA is only available for the purchase of a single acquirable asset (or replacement asset) and is not available for a SMSF to borrow and provide security over an asset the SMSF already owns. Sydney Business Lawyers Page 2
What does single mean? When dealing with land, single: means the land contained within a single allotment (as distinct from a single auto consol title with many allotments) means land contained in more than 1 allotment where legislation stops the allotments being dealt with separately does not mean land acquired under 1 allotment but later subdivided while the borrowing is on foot means land in more than 1 allotment where a physical structure of substance crosses the boundaries of all of the allotments and effectively stops each allotment from being dealt with separately (eg a factory complex built across more than 1 title) means a house or other building contained in 1 allotment normally does not mean a farm which is made up from land contained in more than 1 title (even if all of the land/alotments are contained in the 1 auto consol title) does not mean land where the apartment and car park are on separate titles and there is no legislation that stops the apartment and car park from being dealt with separately If there is more than 1 title/allotment that needs to be dealt with, such as with a farm, the single acquirable asset requirement does not mean that the SMSF cannot borrow to acquire the farm, it means that more than 1 loan will be required. In which case, the lender would probably require the loans to have cross default provisions but they certainly cannot be cross secured in any way. Care needs to be taken that the single acquirable asset held on trust is always the same single acquirable asset purchased with the borrowing. So improvements must not be made to the asset that would cause it to be a different asset. When dealing with securities/shares, single: means securities/shares within the same class (ie it means 10,000 ANZ shares but not 5,000 ANZ shares and 5,000 NAB shares and not 5,000 ANZ ordinary shares and 5,000 ANZ preference shares) does not mean shares acquired from the trading of other shares does mean an off the plan purchase where there is a 10% deposit and a 90% payment of the balance when the apartment is complete does not mean an off the plan apartment and a furnishing package does not mean land acquired as part of a house and land package unless under the package there are only 2 payments, a 10% deposit and a 90% payment of the balance when the house is complete (effectively equating the purchase to a normal purchase of a house) does not mean a contract to build a house on a vacant block of land owned by the SMSF does not mean shares acquired from dividend reinvestment (although, dividends may be reinvested but not without first paying the dividend to the SMSF s bank account and reinvesting it from there) requires the sale of all shares in a parcel of shares that originally meets the single acquirable asset definition (eg if SMSF buys 100 ANZ shares as a single acquirable asset, it cannot sell 1 of them, it must sell all or 100 of them) What does maintaining mean? Maintaining is given its ordinary meaning of work done to prevent defects so long as the work only ensures the functioning of the asset in its present state. Sydney Business Lawyers Page 3
What does repairing mean? Repairing too is given its ordinary meaning of work done to make good defects for the continued use of the asset without changing its character. Repair normally involves replacing only a part of something. A repair to an asset acquired using a LRBA where the repairs are paid for from the funds of the SMSF is OK. Repairs to an asset acquired using a LRBA will only be allowed using funds from the LRBA if the draw downs are provided for under the LRBA. What does improving mean? An asset is improved if the state or function of the asset is significantly altered for the better through substantial alterations or additions. In working out the difference between repairing and improving you look at the quality and character of the asset at the time the LRBA was entered and whether the state of function of it has been significantly altered for the better without reference to the actual use of it Great care must be taken when using non borrowed funds to carry out work on a single acquired asset purchased using borrowed funds. If the work results in an improvement and the asset becoming a different asset, it will breach the rules. What is a replacement asset? It appears from ATO announcements that it will take a narrow view about what would be a replacement asset for the purposes of section 67(4A) of the old rules. That of course is certainly the case for the new rules. The ATO has stated that its interpretation of the definition of a replacement asset requires one borrowing structure to end and a new one to be commenced if there is to be a different underlying asset. What repair and maintenance can be carried out using borrowed money? Under the new rules, borrowed funds can be spent on the repair and maintenance of an asset even if it is money that is not from the same pool of borrowed funds from which the asset was purchased. So long as provision for the repairs and maintenance forms part of the same arrangement, it will be permitted to be used for that purpose. This would require the original loan agreement, the funds of which were used to acquire the asset, to have contemplated the drawing down of money to later carry out repairs and maintenance. Otherwise, if the loan agreement specifically allows for later draw downs or redraws, if that money was used for repairs and maintenance, that too would be permitted (see paragraph 29 of SMSF 2012/1). Replacing / rebuilding v improving In SMSFR 2012/1 the ATO states that replacing or rebuilding with modern equivalent materials is a repair / maintenance but replacing or rebuilding with superior materials is an improvement. Under the old rules, in the Q&A the ATO states that the SMSF trustee could draw down under the LRBA to make capital improvements without breaching SIS. So if you have a pre 7 July 2010 LRBA that does permit for such draw downs for that purpose, it will be permitted. Can borrowing costs such as stamp duty be included in the loan? The SMSF can borrow acquisition costs to complete the purchase. Therefore, the SMSF does not have to fund all acquisition costs such as legal costs stamp duty from its own funds. This issue was not clear under the old rules but the ATO has now clarified in its Q&A that it considered that such costs could be paid from borrowed funds under both the old rules and the new rules. Sydney Business Lawyers Page 4
What should a SMSF do before signing a contract to purchase an asset? Before signing a contract to buy a single acquirable asset using a LRBA it is critical that: any unrelated third party lending is formally approved; and the SMSF knows it will be able to satisfy all of the conditions of that lending. Can a SMSF borrow from a related party? There has never been anything in the borrowing rules to stop a SMSF from borrowing from a related party. The ATO has confirmed in its Q&A that if the borrowing otherwise complies with the requirements of a LRBA, there is nothing to prohibit the lender being a related party of the SMSF. What is the form of the trust on which the custodian must hold the single acquirable asset on trust? The rules do not state what form of trust the single acquireable asset must be held on during the term of the LRBA. In its Q&A, the ATO makes it clear that neither a unit trust nor a discretionary trust will be the right trust structure for a LRBA. Under either, the SMSF will not have the required interest in the single acquirable asset. The trust is a bare trust, which is required not only for compliance with SIS but due to the income tax, GST and stamp duty implications of the trust requirement. Unless a bare trust exists, the LRBA will not work as required. The trust is sometimes called a security trust or holding trust. The trustee of the bare trust is normally called the custodian. The custodian will be subject to the direction of the SMSF trustee about the ownership of the single acquirable asset. Despite being the trustee of the bare trust, the custodian does not do anything other than hold legal title to the single acquirable asset. In fact, it must not perform any positive duties, such as property manage the single acquirable asset. The custodian will not: register for GST or land tax pay the expenses relating to the asset (but of course the SMSF will) prepare financial statements hold a bank account. The custodian will however be the party that enters any lease for the asset as it is the party with the legal title to it. What normally are the requirements of an unrelated third party lender? Our bare trust document has been used for NAB, Westpac, St George, ANZ, Macquarie, CBA, Bank of Queensland, Bank of Melbourne, Bank West and Investec loans. If the loan is from an unrelated third party, such as a bank, the bank s loan and security documentation will need to be signed. Normally, the SMSF trustee will prepare the bare trust that will need to be approved by the bank before the loan can proceed. Some lenders provide the bare trust documentation and the custodian. The bank lender will also need to approve the SMSF trust deed for the purpose of the borrowing. Must the SMSF trust deed permit a borrowing before the LRBA can be entered? The SMSF trust deed must specifically permit the SMSF trustee to borrow and to provide security. If it does not, the trust deed will need to be amended before the loan is drawn down. Sydney Business Lawyers Page 5
What other provisions will an unrelated third party lender such as a bank require in the SMSF trust deed? As a minimum, the SMSF trust deed must also permit the SMSF trustee to: operate bank accounts delegate its powers allow a custodian or nominee to hold the assets of the SMSF carry out transactions despite conflicts of interest grant indemnities otherwise acquire, develop & sell assets What decisions will you need to make before a related party loan is entered? If the loan is a related party loan: there will be a loan agreement there will be a bare trust the loan agreement and the bare trust can be in the same document the terms and conditions of the loan will need to be agreed and comply with the arm s length requirements of section 109 of SIS (ie on terms no more favourable to the lender than had they been dealing with one another at arm s length ) a decision about security must be made Is security required? The SIS rules do not require security. So in a related party loan, the extra cost and complexity of mortgage security documentation can be avoided if the related party lender does not require it and the terms and conditions of the loan otherwise comply with the not more favourable than SIS requirement of section 109. As the asset is held by a custodian until the loan is repaid (ie the security trustee ), not only is security not required in order to comply with section 109 of SIS, a higher interest rate does not need to be charged because there is no mortgage security. The terms no more favourable than in section 109 probably manage the security and interest rate issues. However, the ATO has not issued anything public about this. Despite that, the ATO, in ATOID 2015/27 and ATOID 2015/28 has raised the possibility that without normal arm s length security in place, the non arm s length income provisions of Subdivision 295H (295.550) of the ITAA 1997 may apply. Given the ATO s views expressed in ATOID 2015/27 and 2015/28, to avoid the trust triggering the non arm s length income provisions of Subdivision 295H (295.550), care must be taken to ensure that the terms and conditions of the loan as a whole, including the nature of the acquirable asset, the loan amount, loan term and repayment, interest rate, principal and interest repayment provisions, LVR and security terms and conditions of the loan reflect what they would have been had the parties been dealing with each other at arm s length. So it is important to be able to validate the agreed terms and conditions of the loan with market based evidence and preferably from more than 1 source. This evidence should be kept with the superannuation fund records in case the ATO later claims that the parties were not dealing with each other on arm s length terms and conditions. Even though there is a custodian, until the ATO verifies its approach as to whether the loan needs to be secured to avoid triggering the non arm s length income provisions of Subdivision 295H (295.550), it is best that the loan is secured by first registered mortgage (or other suitable security) and if the superannuation fund trustee is a company, by personal guarantees of the SMSF members (except where they are the lenders). The security and guarantee (if applicable) must be limited recourse in that the security provider s rights against the SMSF must be limited to the SMSF s interest in the asset acquired using the borrowed funds. Sydney Business Lawyers Page 6
What rate of interest must be charged? The interest payable under the loan must be an arm s length interest rate no more favourable than that which it is reasonable to expect would apply if the borrower and the lender had been dealing with each other at arm s length (per section 109(1) of SIS). This is after taking into account all of the terms and conditions of the loan. It is best for the interest rate of a related party loan to be supported by market evidence. Despite that, because section 109(1) of SIS is a no more favourable than requirement at the time the LRBA is set up, the ATO has in fact stated, although not publicly in a way that can be relied on, that a 0% interest rate is acceptable for complying with the superannuation law LRBA requirements. Until the ATO issues a more formal and public position about this, we do not recommend 0% interest rate loans. Even if a 0% interest rate does not breach any superannuation law LRBA requirement, the ATO has publicly stated in ATOID 2015/27 and ATOID 2014/28 that a 0% interest rate will breach the non arm s length income provisions of Subdivision 295H (295.550) of the ITAA 1997. When you order a document package from us, for related party loans you need to nominate the standard interest rate that is to apply. In our documentation, we provide for a 4% default interest rate for non compliance with the terms and conditions of the loan. What LVR is required? The rules do not set out what loan to valuation ratio is required. In the case of unrelated party loans, the SMSF trustee will need to meet the lender s normal LVR requirements. The ATO has stated, again not publicly in a way that can be relied on, that the LVR can be 100%. We struggle with that view but the no more favourable than requirement of section 109(1) probably allows it. Until the ATO issues a public position about this, we do not recommend a 100% LVR. Even if superannuation law allows a 100% LVR, ATOID 2015/27 and ATOID 2015/28 suggest that anything other than a market based LVR will breach the non arm s length income provisions of Subdivision 295H (295.550) of the ITAA 1997. Is there a defined period for repayment of a LRBA borrowing? Unlike Division 7A of the ITAA 1936, there is no prescribed period for repayment of a LRBA loan. Normally, the term of any unrelated third party borrowing will be determined at the outset by agreement between the SMSF and the unrelated third party lender. If the loan is to be repayable on demand: the rest of the terms and conditions of the loan, including the interest rate should reflect this in order to comply with both section 109 and to avoid triggering the non arm s length income provisions of Subdivision 295H (295.550) of the ITAA 1997; if the related third party lender becomes insolvent, the loan will be immediately repayable. If you are concerned about the insolvency aspect and would prefer a fixed term, you must talk about that with us prior to signing any of the documents we supply to you. Can a third party guarantee be given in support of the LRBA? The ATO has confirmed in its Q&A that a third party guarantee can be given in support of a LRBA whether under the old rules or the new rules. Sydney Business Lawyers Page 7
Section 67A(1)(d) now specifically contemplates it but requires that the guarantor s rights of indemnity against the SMSF must also be limited to the SMSF s rights in the purchased asset. That third party can be a member, another related party or an unrelated third party. Is a payment made under a third party guarantee a contribution? Even if the guarantee is limited in recourse as required under section 67A(1)(d), if the guarantee is called on and after satisfaction of the obligation to the lender there is a residue from the sale of the asset and the guarantor forgoes its rights of indemnity against the SMSF, that will result in a contribution to the SMSF with the relevant contribution considerations to be taken into account. This is referred to in the Q&A and is consistent with the provisions of paragraph 175 and following of TR 2010/1. Can a SMSF member or related party be the custodian? It is OK for a member or other related party of the SMSF to be a custodian (as well as the lender). Is an unpaid part of the purchase price a borrowing for the purpose of section 67(4A) - ie is vendor finance permitted? An unpaid part of the purchase price (vendor finance) is not a borrowing for the purpose of the old or new rules. Can you have more than 1 borrowing for the purchase of an asset? The ATO is yet to publicly state that 2 borrowings are acceptable but it has stated in its discussion groups that there is nothing to stop multiple borrowings so long as all other SIS requirements are met. Can you have more than 1 asset held under the same bare trust? It is very clear that only 1 asset can be held under a bare trust at any time. Can a SMSF purchase an asset as a tenant in common with a related party using a LRBA for the purchase of its interest? While a SMSF can acquire a fractional interest in an asset with a related party, the ATO has not expressed a view that clearly permits a SMSF to purchase an asset as a tenant in common with a related party where the SMSF uses a LRBA whether or not the related party uses borrowing or not. Subject to our next comments, our opinion is that by law, it can. If third party lending was required to fund the LRBA, the first issue is that a bank would not normally lend on such a structure unless it could also take a mortgage over the related party s fractional interest. If the related party tenant in common permits a mortgage over the related party s fractional interest in the property, that would be in order. If it was the other way around and the SMSF was not borrowing but the related party was, it would be unlikely that a bank would lend on the security only of the related party s interest in the property (unless of course suitable alternative security was also provided). A security over the SMSF s interest for the related party borrowing would breach SIS regulation 13.14 and simply not be possible. Can the borrower (SMSF trustee) and the custodian be the same? The borrower (SMSF trustee) and the custodian can t be exactly the same party. Some commonality between the custodian and the SMSF trustee is technically possible from a trust law position (eg A&B and A&B or A&B and A), but if they are exactly the same (ie A & A), there will not be a trust and the SIS requirement for the custodian to hold the single acquirable asset on trust will not be met. Commonality between the custodian and the trustee of the SMSF is best avoided in the case of an unrelated third party lending as banks may not accept such arrangements at all. Sydney Business Lawyers Page 8
Can more than 1 SMSF borrow jointly to buy an asset? The ATO has clearly stated that multiple SMSFs cannot jointly borrow to buy an asset under a LRBA. Can 2 parties borrow separately and use their separate borrowings to purchase an asset jointly? Yes, 2 parties can borrow separately and use their separate borrowings to purchase an asset jointly but they will not be able to cross securitise their interest in those assets. That will then become a question of whether the lender will lend on that basis. Can 2 SMSF s purchase an asset as a tenant in common where they both use a separate LRBA to fund the purchase of their interest? 2 SMSFs can purchase an asset as a tenant in common where they both use a separate LRBA to fund their purchase of their fractional interest in the asset. The difficult thing will be to get the bank to lend on this sort of arrangement. If each separate LRBA had a cross default provision in it, that should allow the bank to sell where there is default by only 1 SMSF. Each loan must only be secured against the respective SMSF s interest in the asset. Can multiple borrowings used to purchase different assets be cross securitised? Cross securitisation of assets is definitely not permitted for the purpose of a LRBA. Are multiple draw downs permitted? Multiple draw downs are permitted so long as the single acquirable asset requirement is met and the multiple draw downs are specifically allowed under the loan agreement. For example if an asset in need of repair was being purchased, the loan could allow a draw down to purchase the asset, pay for the purchase costs and separately for repairs and maintenance (so long as those repairs and maintenance did not amount to an improvement). Do banks have any requirements for the SMSF trustee and the custodian? We have found that while banks do have certain requirements that they apply, they are sometimes not consistent with the application of those requirements. In our view, the best structure from the point of view of confidently being able to satisfy bank requirements and succession in the case of death and/or earlier incapacity of a party to the LRBA, is that 2 separate companies should be used as SMSF trustee and custodian. Can you refinance a LRBA? The ATO clearly states in its Q&A that refinancing a LRBA is permissible. However, it is critical that the SMSF trustee does not temporarily obtain title to the asset in the course of the refinance, although, it is difficult to see how that could happen in the normal course of a refinance. Does changing the custodian comply with the LRBA rules? The trustee of a LRBA can be changed without breaching the LRBA rules. The change should be made in compliance with the terms and conditions of the bare trust deed, strictly in accordance with all applicable state and territory laws about changing a trustee, including all registration and stamp duty rules and resettlement issues. Do the SMSF members have to be directors and shareholders of the custodian? There is no SIS requirement for the SMSF members to be directors and shareholders of the custodian. Sydney Business Lawyers Page 9
Care may need to be taken to ensure that the required control of each entity can be maintained as required. (Eg, if the lender is a member s father, the lender may want to control the corporate custodian at both director and shareholder level) Is it possible to change the terms and conditions of the bare trust on which the asset is held under the LRBA? Yes, the terms and conditions of the bare trust can be changed in accordance with the normal trust law rules for changing a trust deed. So, if the bare trust deed specifically allows for a change, it can proceed. If the bare trust deed does not specifically allow for it to be changed there is case law that assists overcome the problem created by that and advice should be taken (without the need to seek court approval). What causes a LRBA started under the old rules to change and be subject to the new rules? In the Q&A, the ATO confirms that if something happens that alters the character of the LRBA in a significant way (either directly or indirectly), there is a new LRBA and it will be subject to the new rules. For example: the pre 7 July 2010 LRBA is refinanced varying the term of the borrowing, depending on the extent of the variation changing the directors of the corporate SMSF trustee (and its members) and of the corporate lender - although, if the directors of the corporate SMSF trustee were only changed due to the admission of 2 new members, that would not cause the LRBA to move from the old rules to the new rules. Do the borrowing and security arrangements breach regulation 13.14 of SIS about the charging of assets? No carve out appears in regulation 13.14 of SIS to permit an SMSF to charge its asset under a LRBA. Despite that, the ATO has confirmed in its Q&A that if the acquisition, borrowing and security arrangements are otherwise in compliance with the LRBA provisions, a charge will be permitted. Are there any acquisition from related party issues when the single acquirable asset is finally transferred to the fund? The ATO has confirmed in its Q&A that when the single acquirable asset is transferred to the fund once the loan has been repaid, the transfer will not contravene the existing prohibition on an SMSF acquiring assets from a related party. Must the bare trust be unwound when the loan is repaid? The ATO s view in its Q&A is that there is no absolute requirement for the asset to be transferred from the custodian to the SMSF trustee when the borrowing is repaid but the asset would normally count as an in house asset. However, the Self Managed Superannuation Funds (Limited Recourse Borrowing Arrangements-In-house Asset Exclusion) Determination 2014 Legislative instrument, registered on 10 April 2014 indefinitely excludes an asset held on bare trust from being an in house asset, even after the loan is repaid. Don t forget the investment strategy? All SMSFs must have an investment strategy. If the SMSF does not already have a strategy, one will need to be prepared and adopted and continually reviewed once it has been adopted. If an existing investment strategy does not permit the proposed investment, it will need to be updated. Sydney Business Lawyers Page 10
What about the sole purpose test? It is important that the sole purpose test is not forgotten in the excitement to access this seemingly generous legislative concession that has re-opened the borrowing door for SMSFs that was closed in 1999 with the changes to the in-house asset rules and the general outlawing of new geared unit trusts from 11 August 1999. What about CGT? There is now legislation that deals with what happens when an asset permitted to be purchased under the borrowing rules is eventually transferred to the SMSF trustee by the custodian. So there will be no unwanted CGT issues when that transfer happens. The legislation goes further and simply treats the SMSF trustee as the owner for all taxation purposes. A look through approach. The legislation is retrospective to 24 September 2007, when the borrowing rules were first introduced. What about GST? Depending on the type of single acquirable asset being acquired, GST may need to be taken into account on the purchase of the asset and then during the ownership of it. If GST registration is required including because the income threshold is met or due to claiming input tax credits, while the custodian owns the single acquirable asset, it will normally be the SMSF trustee that is registered for this purpose (see GSTR 2007/D3). In our view, when the custodian transfers the single acquirable asset to the SMSF trustee, there is no taxable supply because the custodian is not carrying on an enterprise in relation to the asset. The ATO has expressed the view in its Q&A that even if there was a taxable supply and the deemed market value consideration rule applies, for the purpose of Division 72 of the GST Act, the deemed market value of the supply would be nil. What about land tax? If the single acquirable asset is land, land tax may apply. Under a bare trust, while NSW land tax rules mean the custodian and the SMSF trustee will be liable to land tax, the SMSF trustee will be entitled to a credit for land tax paid by the custodian. As the bare trust is not a special trust, the custodian will normally be entitled to the tax free threshold. Despite that, the OSR has advised that if the bare trust documentation is presented with a land tax registration application, they will accept that only the SMSF trustee needs to be registered for land tax. Make sure that is confirmed in writing when attending to the registration. What about Division 7A? If the lender is a company, care must be taken to ensure that the loan arrangements comply with Div 7A of the ITAA 1936. We include an unsecured loan deeming clause in our documentation as a compliance safety net. This deeming clause will not fix any non compliance with the 110% loan to valuation ratio requirement of Div 7A that must be satisfied at the time the loan is drawn down if a 25 year loan term is required for Div 7A purposes. Neither will it fix any requirement for security to access the 25 year loan term requirements. Sydney Business Lawyers Page 11
What about stamp duty? No state or territory in Australia charges stamp duty on a loan. Stamp duty will not normally be payable in any state or territory of Australia on any purchase or later transfer of listed securities. Stamp duty is normally payable in all states and territories of Australia on any purchase or declaration of trust over land and any later transfer of that land. However, subject to the following notes, only nominal stamp duty normally applies on both the bare trust documentation [in NSW of $500, Victoria $0, Tasmania $20, ACT $20, Northern Territory $5, Western Australia $20, Queensland $0 and South Australia $0] and when the purchased asset is later transferred from the custodian to the SMSF trustee similar nominal stamp duty applies. However, in all of those states and territories, that is only the case if the SMSF can prove that it paid for the purchase price of the asset either from its funds or from a loan. It will not be sufficient to simply claim that the SMSF has paid the purchase price, it has to be physically proven from reconciling purchase contracts and settlement statements to the payment of the purchase price through producing bank statements and loan documents. If the purchase of the asset has not yet been completed when the stamping needs to be done (such as before settlement of a bank loan), the loan agreement will also need to be supplied to the office of state revenue as part of that process. Note If the asset is not dutiable property, such as a listed security, the initial declaration of bare trust may be liable to duty, in NSW of $500, Victoria $200, Tasmania $20, ACT $0, Northern Territory $0, Western Australia $0, Queensland $0 and South Australia $0. In the Northern Territory and South Australia, the bare trust documentation must be executed prior to any contract to purchase the asset and you need to be able to prove that. Signing and dating the bare trust 1 day prior to the purchase contract is the best way to do this. If a charge / mortgage is granted over the asset to be purchased under the agreement, stamp duty would normally be payable on that charge / mortgage in NSW. Mortgage duty was abolished in South Australia from 1 July 2009, Western Australia from 1 July 2008, Victoria since 2004, Tasmania from 1 July 2007 and Queensland from 1 July 2008. There is no mortgage duty in the ACT or Northern Territory. In NSW, Victoria & Tasmania, interest will normally be charged on unpaid stamp duty from the date 3 months after first execution of any document that is liable for stamp duty. In the ACT, it is 90 days. In the Northern Territory it is 60 days & Queensland, 30 days. In Western Australia & South Australia, lodgement must take place within 2 months. In Western Australia penalties of up to 10% apply for late lodgement & in South Australia, interest and penalties can apply. Can interest be capitalised? The ATO in its Q&A confirms that capitalisation of interest under a LRBA is permitted if the interest relates to the borrowing for the purchase of the single acquirable asset and the LRBA permits for capitalisation. Who maintains the accounting records for the single acquirable asset? Even though the single acquirable asset is held by the custodian as bare trustee for the SMSF, it is the SMSF trustee that should account for all transactions about the asset. Does the ATO have any outstanding views on LRBA s? Please note that the ATO is yet to formally make a public statement that can be relied on about: a 100% LVR no security loans 0% interest rates the treatment of the capital protected borrowing provisions of Division 247 Sydney Business Lawyers Page 12
What if a LRBA was entered before 24 September 2007? The ATO has advised that if a LRBA otherwise complies with the laws it will not issue a notice stating the SMSF is a non-complying fund solely on the basis that the investment was made before 24 September 2007. However, the ATO does state that if the SMSF invested in a LRBA before 24 September 2007 and it breaches the laws, the ATO will decide on a case-by-case basis what the SMSF must do to become compliant. For example, it may impose a penalty, or if possible, require the breach to be fixed. If you have any questions about our newsletter or would like to know more about LRBA s, please do not hesitate to contact us. A copy of our order form can be downloaded from our website. Author Damian Scroope Warning This material has been prepared on the basis of our current understanding of the Government s and the ATO s position about the LRBA laws and the ATO s interpretation of them. These may change and this newsletter is not intended to be a complete summary of all superannuation, taxation and other issues about LRBA s. The information in this newsletter is general in nature and is not intended as legal advice or financial advice. Sydney Business Lawyers is not able to give you financial advice. You should not do or fail to do anything in reliance on information set out in this newsletter. We do not accept any responsibility for any loss that you suffer if you do. If you would like to receive Insights electronically please forward your email address to mail@sydneybl.com.au Sydney Business Lawyers Page 13