Can an asset be left in an LRBA bare/holding trust once the loan is paid off?
The short answer is probably going to soon become yes.
I will explore this fully in this article. In exploring this, a very critical tip for advisers emerges: it is vital that the deposit is paid from a bank account in the name of the SMSF. This is despite recent draft legislative changes that will allow the asset to stay in the bare/holding trust after the loan is paid off (see http://www.ato.gov.au/Super/Self-managed-super-funds/In-detail/News/General-information/Limited-recourse-borrowing-arrangements/).
Naturally, in order for an SMSF trustee to borrow under an LRBA, the asset must be held on trust. More specifically, the asset must be held on trust so that the SMSF trustee acquires a beneficial interest in the asset.
Accordingly, the asset is not held in the name of the SMSF trustee. Rather, it is held in the name of another entity. Industry often refers to this entity as the ‘bare trustee’. The ATO refers to it as the ‘holding trustee’. In this article, I’ll refer to it as the ‘bare/holding trustee’.
There is a view that the bare/holding trustee structure causes an in-house asset issue. After all, strictly speaking, the asset that the SMSF trustee has is an interest in the bare/holding trust. Therefore, this bare/holding trust can be seen as a related trust, and an investment in a related trust is seen as an in-house asset. SMSFs typically are not allowed to have more than 5% of their assets in in-house assets.
To counteract this in-house asset concern, the legislature added an exception to the in-house rules. See s 71(8) of the Superannuation Industry (Supervision) Act 1993 (Cth). It broadly provides that an investment in a related trust that was made in order to meet the LRBA requirement is excepted from constituting an in-house asset.
The problem: when the loan is paid off
When the loan is paid off s 71(8) becomes ineffective, and the value of the interest in the bare/holding trust (ie, typically the value of the underlying asset) then becomes an in-house asset. This once again creates an in-house asset issue within the bare/holding trustee structure.
It has been put to the ATO that they should ignore the bare/holding trust and treat the SMSF as if the SMSF trustee owned the underlying asset itself. Although the ATO stated that they would discuss the issue further, they also said that when the loan was paid off, the SMSF would then have an in-house asset. See item 6.2 of the September 2010 NTLG (superannuation subcommittee) minutes.
The strict effect of this has been that, when the loan is paid off, the asset must typically then be transferred from the bare/holding trustee to the SMSF trustee.
The fix: legislative change
The ATO have released a proposed legislative fix. The fix is called ‘Legislative Instrument – Self Managed Superannuation Funds (Limited Recourse Borrowing Arrangements – In-house Asset Exclusion) Determination 2013’.
It proposes to alter the legislation so that s 71(8) would continue to excuse the investment in the bare/holding trust from constituting an in-house asset even after the loan is paid off.
Why the fix is important
If the investment in the bare/holding trust is an in-house asset when the loan is paid, then generally the underlying asset must be transferred from the bare/holding trustee to the SMSF trustee.
Naturally, such a transfer would give rise to various transaction costs, including conveyancing fees.
If the asset is real estate, this is a transfer of dutiable property. Therefore, at face value it gives rise to another round of full ad valorem stamp duty liability. Typically, there is a stamp duty exception/concession that may apply. However, there is no guarantee that the exception/concession will definitely apply. Rather, certain requirements must be met in order to qualify to utilise this exception/concession.
One requirement may be that the SMSF trustee must provide all of the purchase money including the deposit. However, sometimes the deposit is not paid from a bank account in the name of the SMSF. Rather the deposit might have been paid, for example, from a bank account in the name of a member and then treated as journalised contribution.
The problem is that the relevant revenue authority, in determining whether or not to grant the stamp duty exception/concession, might want to see bank statements in the name of the SMSF showing the payment of the deposit. For example, the Victorian SRO Evidentiary Requirements Manual states that they want to see:
Copies of relevant financial statements and other evidence showing the source of purchase money, including the deposit monies.
Without a bank statement showing the deposit leaving the bank account in the name of the SMSF, eligibility for the stamp duty exception/concession may be jeopardised.
Some wish to leave the asset in the bare/holding trustee’s name, even after the loan is repaid. This legislative fix would mean that doing so would not cause in-house asset issues from a superannuation law point of view.
If an asset is left in a bare/holding trust, can the asset be ‘replaced’?
One of the requirements of LRBAs is that the asset being acquired cannot be replaced during the life of the loan.
If the asset is subdivided, or otherwise fundamentally altered, the ATO considers this to be a replacement. See ATO self managed superannuation fund ruling SMSFR 2012/1. Accordingly, SMSF trustees that want to significantly improve/alter assets they acquired with LRBAs must first discharge the borrowing.
However, under the proposed change to the law, this might not be allowable if the asset is left in the bare/holding trust.
The draft legislative fix states that in order for the investment in the bare/holding trust to not be an in-house asset once the loan is repaid, s 71(8) must have had the ability to apply ‘but for the fact that that borrowing has been repaid’. However, in order for s 71(8) to apply, the asset acquired must not have been replaced!
Therefore, if the asset is left in the bare/holding trust, under a strict reading of the proposed new law, it appears that the asset can not asset be ‘replaced’ even after the loan is paid off. Hopefully, a practical approach will be adopted in due course. However, for the time being the conservative approach is to assume that if the asset is left in the bare/holding, it can not be fundamentally altered (ie, ‘replaced’).
Therefore SMSF trustees that wish to borrow in order to acquire an asset, and then one day proceed to fundamentally alter the asset, may still have to transfer the asset from the bare/holding trustee to the SMSF trustee. If they do, they should naturally ensure they have all the relevant evidence to support their duty exception/concession.
The proposed legislative change could be very positive in that it will allow an asset to be left in a bare/holding trust even after a loan is repaid without resulting in an in-house asset issue. However, the proviso is that asset might not be able to be replaced. Thus, SMSF trustees that wish to ‘replace’ (eg, by way of improvement) the asset may still need to transfer the asset from the bare/holding trustee to the SMSF trustee.
In order to help ensure that this subsequent transfer can occur with minimum unnecessary stamp duty, it is vital the initial deposit was paid from a bank account in the name of the SMSF.
We are also hoping the ATO will soon clarify that once the loan is fully repaid under a limited recourse borrowing arrangement that there will be no further need to worry about this issue. Here’s hoping for a positive and practical resolution.
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.