GUEST POST: Understand the state jurisdictions when establishing LRBAs


the-law

The ATO’s recent release of Taxpayer Alert – TA 2012/7, provide trustees and professionals with a timely reminder about acquisition of property using a Limited Recourse Borrowing Arrangement (LRBA) and also through related unit trusts.

Some of the examples of concern raised by the Commissioner in TA 2012/7 surrounding LRBAs suggest individuals are either:

  • oblivious to the appropriate legislative provisions; or
  • not seeking the appropriate advice prior to entering into the property acquisition.

Of most interest from the features that concern the Commissioner, was the following statement:

“The trustee of the holding trust is not in existence and the holding trust is not established at the time the contract to acquire the asset is signed” [Arrangement 1, item (c)]

Whilst this may be a true statement for some state jurisdictions, this is not necessarily the case across all States and Territories of Australia.  For example, Victoria’s conveyancing and stamp duty laws do not prohibit nor penalise parties when they incorporate and establish a Trust in contemplation of being the nominated party for a property transaction that is already on foot.  It is commonplace in Victoria for parties to be nominated to complete a property acquisition to which they were not the original party. Usually, the initial Contract of Sale provides a nomination provision. If this is not the case, there is a statutory provision that enables a nomination of the purchaser of a property in Victoria within 14 days of the date of settlement.  Any nomination is subject to the nominated party completing the transaction. If this not be the case the original purchaser is still liable to settle.

Additionally there is no stamp duty penalty if there is a nomination of a substituted purchaser that does not equate to a second sale.

The fact that the Custodial Trustee and the Bare Trust has not been established prior to the execution of the Contract for the property that is eventually acquired by the SMSF as law would be irrelevant in Victoria.

With a LRBA via nomination adhering to all of the provisions of section 67A & 67B of the SIS Act, it is difficult to determine what offends SIS or the ATO in respect of such arrangements?

The prohibition described by the ATO where the Custodial Trustee and the Bare/Holding Trust has not been established prior to the execution of the contract may in fact offend some State stamp duty provisions that would lead to double Stamp Duty.

The “lore” described by the ATO where the Custodial Trustee and the Bare Trust has not been established prior to the execution of the Contract may not be found offensive in Victoria.  I would submit that the Victorian courts would question the ATO’s motives by making such a statement.

Only time will tell, but invariably frightened parties will shy away from when a good real estate investment opportunity presents itself to a SMSF.

Written by Ian Glenister, Solicitor

Legal Officer & Co-founder, The SMSF Academy

Alarms bells ringing with ATO around property investing in SMSFs


After only just discussing the regulatory focus by ASIC on SMSFs and property investments, we have seen further regulatory “alarm bells” ringing through the ATO’s release of taxpayer alert, TA 2012/7.  A Taxpayer Alert is an “early warning” of significant new and emerging higher risk tax and superannuation planning issues or arrangements that the ATO has under risk assessment, or where there are recurrences of arrangements that have previously been risk assessed.  With the growing amount of ‘hype’ in the use of these type of strategies, the alert is a timely reminder to ensure such arrangements comply with the strict nature of superannuation law.

It is often lost in the conversation, that borrowing is ordinarily prohibited in superannuation.  Limited exceptions apply, with the ability to enter into a limited recourse borrowing arrangement for prescribed purposes.  The specific purpose of the borrowing must be for the acquisition of a ‘single acquirable asset’.  To say ‘near enough is good enough’ simply won’t cut it when it comes to compliance with these requirements.  Failure to comply with sections 67A & 67B of the SIS Act, will mean that any maintenance of the loan will be in breach of the borrowing provisions.  With an inability to sell a brick-at-a-time, the unwinding of these arrangements can be difficult, and potentially expose the fund to a significant loss on a forced sale.

What problems are the ATO seeing with property investments using LRBAs?

  • The borrowing and title of the property is held in the individual’s name and not in the name of the trustee of the holding trust.  The SMSF has paid the deposit and ongoing repayments;
  • The title of the property is held by the trustees of the SMSF, not the trustee of the holding trust;
  • The trustee of the holding trust is not in existence and the holding trust is not established at the time the contract to acquire the asset signed;
  • The SMSF acquires residential property from a member;
  • The acquisition comprises two or more titles and there is no physical or legal impediment to the two titles being dealt with, assigned or transferred separately; or
  • The asset is a vacant block of land, with the intention to construct a house on the land.  The land is transferred to the holding trust prior to the house being built.

These problems throw up a whole range of compliance concerns, including:

  • potential breach of the sole purpose test in section 62 of SISA;
  • failure to comply with section 67 which prohibits a SMSF from borrowing money or maintaining a borrowing;
  • the acquired asset not meeting the single acquirable asset definition under section 67A(2) as it comprises two or more proprietary rights;
  • the acquirable asset is subject to a charge which would prohibit the fund from borrowing money or maintaining a borrowing of money under section 67A(1)(f); and
  • where the title is incorrectly held in the name of the individual and not the trustee of the holding trust, the deposit and/or loan repayments may breach the payment standards, effectively drawing on preserved benefits prior to meeting a cashing condition.

As highlighted by the Commissioner, there is a lot of talk about the benefits of limited recourse borrowing in super, but not a lot about the risks.  It is important to remember, responsibility ultimately rests with the trustees to comply with superannuation law.  Ensuring that the fund’s governing rules allow for borrowing (and assets to be held in a custodian arrangement), and that the decision is consistent with the fund’s investment strategy are all critical elements to ensure compliance.  Failure to do so, can render the fund non-complying, effectively meaning the fund is subject to a 45% tax rate which is applied to its income and market value of fund assets (other than undeducted contributions).  Furthermore, civil and criminal penalties could also apply.

Related trust arrangements

The taxpayer alert also highlights a range of concerns around the use of related unit trust structures to acquire property.  Once the ‘darling’ of the SMSF sector, the use of unit trusts has somewhat diminished with the inability to typically leverage inside these trusts, nor put a charge over the assets of the trust.  These strict requirements are outlined within SIS Regulation 13.22C.

The ATO concerns with these arrangements appear to stem from investments that are failing to adhere to the requirements of SISR 13.22C and subsequently become in-house assets under section 71 of SISA, thereby counting towards the allowable 5% limit.

It is not to say these strategies don’t provide some fantastic outcomes for individuals, but the decision process to establish a SMSF and consider acquiring property is not something to be taken lightly.  These alerts and investigations by the Regulators highlight the need for “buyer-beware” when it comes to property in SMSFs.

 

WEBINAR – SMSF limited recourse borrowing arrangements


 

The topic of borrowing in super continues to gain momentum with a growing number of SMSFs looking to establish limited recourse borrowing arrangements (LRBAs) to acquire property.

The next SMSF Academy webinar will discuss the latest issues impacting LRBAs including:

  • Understanding the Commissioner’s views in the final ruling, SMSFR 2012/1: application of key concepts with LRBAs
  • Update on the proposed licensing requirements
  • Considerations of insurance with LRBAs
  • Latest ATO issues with related party loans, interest rates, multiple loans, off-the-plan acquisitions and much more

Find out more and register here

 

Zero interest in SMSF borrowing?


Whilst the interest in limited recourse borrowing within self-managed super funds appears to be rising, the opposite has been posed to the  Australian Taxation Office in respect to the level of interest than may be applied to a related party loan.

The June 2012 NTLG minutes posed the question as to whether a zero percent interest rate could be applied to related party loan in accordance with the provisions of section 67A of the SIS Act, which outlines the requirements of a limited recourse borrowing arrangement.  This question follows the ATO’s interpretative decision ATOID 2010/162 which confirms that a fund is dealing at “arm’s length” where the terms are more favourable to the SMSF.  What wasn’t outlined within the interpretative decision was whether the differential in ‘market rates’ versus a lower interest rate could constitute a contribution.

In an interesting outcome from this meeting, it is the views expressed by the ATO confirm that a zero percent interest rate can be established with a related party LRBA loan without the discrepancy between what is ‘commercial’ and the lower rate offered to the fund being classified as a contribution.  Consistent with the views express within SMSFR 2009/2, regarding the meaning of ‘borrow money’ or ‘maintaining a borrowing of money’, the most important element is that a genuine loan is in place (where it can be shown that there is an intention that the loan will subsequently be repaid to the lender).  Whilst a borrowing arrangement will usually involve an interest charge, the fact that no interest (or a lower interest rate) is charged will not, of itself, preclude the loan arrangement from being a borrowing.

It is important to remember that nothing within the borrowing exception of s67A of the SIS Act prescribes that a rate of interest must be applied in respect to the fund entering into a borrowing arrangement.

The release of this information by the ATO has already sparked the interest of many as a way to further improve ‘inflows’ into superannuation for many members who have been ‘capped out’.

What do you think about the ATO’s views expressed about SMSFs being able to provide 0% interest rate loans?

How the Commissioner’s views on borrowings could spark a property developer’s frenzy on SMSF trustees


It quite amazing how far we have come with limited recourse borrowing arrangements over the nearly 2 years since changes were introduced on 7 July 2010.  Many people would recall at that time of the introduction of sections 67A and 67B into the SIS Act that many within the industry were highly critical of the very strict limitations that appeared to be imposed with the single acquirable asset definition, along with the supposed inability to make any changes to a particular asset held under such a borrowing arrangement.

The final SMSF ruling, SMSFR 2012/1 on the application of key concepts with limited recourse borrowing arrangements has certainly seen this view come full circle as the practical approach taken by the Commissioner within this ruling provides both clarity and some exciting opportunities for the acquisition of real property within a self managed super fund.

With the property market facing its own challenges in respect to attracting buyers, we have seen a shift with property developers looking to target the SMSF market to promote property to trustees as part of their fund’s investment strategy.  The original draft ruling issued in September 2011 provided clarity around the ability for a fund to acquire off-the-plan apartments, where the borrowing arrangement was entered into at the time the property was completed and strata-titled.  It appears that the final ruling, SMSFR 2012/1, has expanded the Commissioner’s view in respect to how a LRBA can be entered into to acquire property to be developed (whether an off-the-plan apartment or house and land).

So what has changed from the draft ruling to the final ruling in respect of property development?

The draft ruling discussed that a borrowing could only be entered into for an off-the-plan purchase once the property had been completed and strata titled.  This meant that the SMSF was required to fund the initial deposit and then obtain the SMSF limited recourse loan for the completion of the property.  This view appears to have slightly changed within the final ruling whereby, if a contract is entered into for an off-the-plan purchase of a strata titled unit (that is, the purchase of a unit that is yet to be built and strata titled) and under the contract a deposit is required upon entering into the contract with the balance payable at settlement after the unit is built and strata titled, each payment is applied for the acquisition of that strata titled unit.  Providing that the strata titled unit is a single acquirable asset, the deposit and the balance payable at settlement may be funded under a single LRBA.

The final ruling also expands in the construction of a house on land through the use of a limited recourse borrowing arrangement.  Previously it has been the understanding that when it came to the development of house and land, the draft ruling inferred that the land was the single acquirable asset and once a property is added it becomes a different asset (replacement), which is not permitted under section 67B.  Whilst this to some extent remains true, the final ruling outlines that a similar outcome results (to a OTP apartment) if the contract entered into is for the purchase of a single title vacant block of land along with the construction of a house on that land before settlement occurs.  In this situation the deposit paid upon entering into the contract and the balance payable upon settlement is applied for the acquisition, under that contract, of land with a completed house on it. The deposit and the balance payable at settlement may be funded under a single LRBA.

The ruling provides two examples of how structuring the purchase of house and land will ultimately dictate what is a single acquirable asset:

Purchase of land and construction of house using borrowings

The trustees of an SMSF want to enter into a LRBA where the single acquirable asset is a vacant block of land.  The SMSF intends that the borrowing will provide sufficient funds for the construction of a house on that block. Assuming that title to the vacant land transfers to the holding trust prior to the house being built, it is the vacant land that is acquired and held on trust under the LRBA .  This arrangement will cease to satisfy the requirements of section 67A if money borrowed under the LRBA is subsequently used to construct the house and thus improve and fundamentally change the character of the asset held on trust (that is, from vacant land to residential premises ).  This outcome is not altered even if the contracts entered into for the acquisition of the land and the construction of the house contain clauses linking the two contracts .

Acquisition of a yet to be constructed house on land using borrowings

The trustees of an SMSF want to enter into a contract to acquire, as a ‘package’, land with a yet to be constructed house on it and to fund the acquisition using borrowings under a LRBA. As the contractual arrangement is for the acquisition of land with a completed house on it, and settlement occurs once construction of the house is finished, the deposit and the payment on settlement can be funded under a single LRBA .

It is the Commissioner’s view that the second arrangement is for the acquisition of a single acquirable asset, being the land with the house constructed on it, as distinct from the first where the single acquirable asset is the land only.

The view’s expressed within this final ruling certainly open the doors for SMSF trustees to consider a greater range of new property development opportunities using limited recourse borrowing arrangements.  I think it would be fair to say property developers will certainly be ready and waiting.

(C) The SMSF Academy 2012
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