Compliance traps flagged with personal guarantees for LRBAs

Mr Butler noted that back in mid-2019 the ATO issued letters to almost 18,000 SMSFs which had invested 90 per cent or more of their funds’ assets in one asset, prompting them to review their investment strategy to ensure there was adequate diversification.

“The majority of these involved an LRBA in property when the market was expected to suffer a downturn,” said Mr Butler.

There may be funds with questionable properties that are highly leveraged, he warned.

“If these sorts of funds suffer a 20 to 30 per cent decrease in the value of their property or the tenant runs away, they will be stretched.”

Where a fund is sitting on a significant loss with a property asset or isn’t going to make it financially, Mr Butler said SMSF clients should be aware that as trustees they are required to act prudently and in their members’ best financial interests.

He noted that some SMSF trustees will be reluctant to walk away from a poor investment as they are guarantors for the loan.

“The lenders won’t even bother getting their hands dirty, they’ll just go to the guarantor, tip them upside down and shake out their pockets for the money and the super fund could be left there sorting out the problems,” he cautioned.

“So guarantors are personally liable for the deficiency and the lenders will go straight to the guarantors for the money. If the guarantor is not liquid then they’ll go to the super fund and get their money but they take the easy route [first].”

The ATO outlined in ATO ID 2010/170 that where there is a call on the guarantee resulting in the guarantor paying the money out, that will result in the guarantor stepping into the shoes of the lender, Mr Butler explained.

“The guarantor can then recover its money under the guarantee from the super fund. So in effect, the lender is stepping out and the member or the guarantor is stepping in as the lender.”

The ATO also stated in ID 2010/170 that unless the rights of the guarantor against the trustee are limited to the rights relating to that asset, then that would breach SIS.

Mr Butler noted that there was different law that applied before 7 July 2010 (under s 67(4A)). After 7 July 2010, under section 67A, the right of lenders was limited to the asset, he said.

“However you really need to read guarantees very carefully because some guarantees not only allow for recovery against the asset but they ask for legal fees, accrued interests and costs of recovery. So watch out for guarantees,” he cautioned.

He warned that a guarantor could potentially be deemed to make a contribution under the guarantee.

“This will arise in circumstances where for instance, the right of indemnity expires. With a personal right, you can generally only recover within six years,” he explained.

“So, for example, if the guarantor has a right against the super fund, then has the super fund insisted upon that right being lived up to? If the super fund has been paying the guarantor then that right of expiry has not ceased.

“However, if there hasn't been any action by the guarantor to get the super fund to pay the guarantor back, then there is an issue with a deemed contribution.”

Mr Butler said that some guarantors may not have considered this given that the lender has been paid out.

“In effect, there is still a lender [though], the lender is now the guarantor standing in the shoes of the lender.”

“So if the super fund still owes money under the guarantee to the related party, then that's okay, that doesn't provide you with any immediate problem. However, you still have to manage the statute of limitations where the six year expiry period could run its toll,” he explained.

“In order to refresh you need to have payment and acknowledgement of the debt with relevant notifications, and a response to those relevant notifications.”

Moreover, the non-arm’s length income risk needs to be managed if regular monthly repayments in accordance with PCG 2016/5 have not been made by an SMSF to the guarantor.