29/11/2012

The Australian Tax Office issued a new Taxpayer Alert TA 2012/7 on 20 November 2012 which outlines the ATO’s concern with a number of scenarios relating to limited recourse borrowing arrangements (LRBA) by SMSFs.
 
The Alert deals with issues under two main headings – property investments using limited recourse borrowing arrangements (LRBAs) and property investments using related unit trusts.  This article comments only on the first of these.

In relation to common or garden variety LRBAs the ATO lists six scenarios that cause them difficulty.  They are:

• the borrowing and the title to the property is held in the individuals’ (sic) name and not in the name of the trustee of the holding trust and the SMSF pays part of the initial deposit and the ongoing loan repayments
• title to the property is held by the SMSF trustee not the holding trustee
• the trustee of the holding trust is not in existence at the time of the purchase contract and nor is the holding trust
• the SMSF trustee acquires residential property from the SMSF member
• the acquisition comprises two or more titles that can be dealt with separately
• the asset is a vacant block of land that the SMSF intends to improve by building a house

We have consistently advised that these scenarios are non-compliant with the law and we have never allowed a client of ours to enter an LRBA using any of the six scenarios.  Specifically we note in respect of each of the scenarios listed above:

• the SIS Act requires that the property be purchased by and be held in the name of the holding trustee, not an individual member
• same issue as (a)
• see our comment below
• only "business real property" (as defined) can be purchased from a related party
• only a single acquirable asset can be purchased using an LRBA, so multiple titles that can be dealt with separately must involve multiple LRBAs
• a vacant block purchased using an LRBA and which is then improved becomes a replacement asset that does not comply with the s.67B of the SIS Act.

Some confusion in the market surrounds scenario (c).  This scenario is where 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.  Note that this scenario has two limbs, namely that the holding trustee is not in existence AND that the holding trust is not established at the date of the contract. 

We agree totally with the ATO that the holding trustee must be in existence when the contract to acquire the asset is signed because it is the holding trustee who is acquiring the property. 

However it is not possible in some States (NSW, ACT and TAS) to execute the holding trust deed before the contract to acquire the asset as this could lead to full ad valorem duty being levied twice – once on the declaration of trust and once on the contract (see for example Platinum Investment Management Ltd v Chief Commissioner of State Revenue (No.2) [2010] NSWSC 1).

The ATO appears to be concerned, and rightly so, that if the contract were signed before the holding trustee was even in existence (and therefore before the holding trust could exist) the deposit paid by the SMSF and or the loan repayments by the SMSF may be considered as a payment of superannuation benefits given the requirement that the title of the property be held by the trustee of the holding trust.

However, provided the holding trustee is in existence and enters the contract, the mere fact that the holding trust deed is signed thereafter does not invalidate the LRBA.  Provided all the deposit is paid by the SMSF, the holding trustee holds the property in a resulting or implied trust until the deed is actually executed thereby formalising the trust. Normally all of this occurs before completion of the purchase thereby making the situation clearly compliant when the purchase takes place. 

The minutes of both the holding trustee and the SMSF trustee, which we provide with our document pack and which we advise be signed before the contract, make the situation quite clear.

The process of executing the holding trust deed after the contract will safeguard against double stamp duty in NSW, ACT and TAS and will not of itself breach the requirements of the SIS Act in respect of LRBAs.

If you have any questions in relation to this article, please don't hesitate to contact Caroline Harley or Rebecca Partington at TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.