Speaking in a recent Accurium CPD+webinar, Seamless SMSF specialist auditor Frank La Spada said that limited recourse borrowing arrangements are one area where he consistently receives queries and problems about throughout the year.
“We see problems with [LRBAs] both in terms of both your stock standard borrowings and more complex arrangements as well,” said Mr La Spada.
Mr La Spada said it’s important that SMSF professionals are aware of some of the common traps that clints fall into that can cause these strategies to come unstuck.
For SMSFs with related party loans, one of the common issues that crops up, he said, is SMSF trustees following some but not all the terms listed in PCG 2016/5.
“Often what we’ll see is that some of the rules are followed but not all of them. For example, the correct interest rate has been used but there is a 30 year loan term instead of 15 years.”
“We also see charges not being place over the property, annual repayments being made instead of months and even loan agreements that haven’t been written and executed.”
Where an LRBA does not meet all of the safe harbour terms in PCG 2016/5, they will not any assurance that the Commissioner will accept the arrangement as an arm’s length dealing.
Mr La Spada noted that while SMSF trustees are not required to follow the terms of PCG 2016/5, where they choose not to follow the guideline, the onus will be on them to prove that the arrangement is an arm’s length dealing.
Proving that an arrangement is an arm’s length dealing is more than just jumping onto a lender’s website and finding out what the latest SMSF loan rate, he stressed.
“You need to go through the entire process with a commercial lender to facilitate a limited recourse borrowing arrangement up until the point where a letter of offer is issued.”
Missing documentation is another common problem that his firm comes across, he said.
“We may have a complying arrangement but if we can’t cite all the documents then we can’t give it the tick.”
He gave the example that an SMSF auditor will want to see that the trust deed for the fund actually allows for the LRBA to take place.
“Some deeds may not even allow for an LRBA to take place where a related party lender is used.”
While commercial lenders would typically check these kinds of documents before offering the loan, it’s important to check this where a related party lender has been used.
Mr La Spada said the auditor will also want to ensure that the asset held under the bare trust matches what’s in the financials and loan agreements.
“Regardless of whether it’s a bank lender or a related party lender, the auditor will need to see those loan agreements.”
For related party loans, it’s a good idea to have a loan repayment schedule on file as well.
“From an auditor’s perspective, we might know that it’s a 15-year term and that principal and interest is being paid monthly but if we don’t have a schedule to show what the balance of the loan is and how we’ve gotten to that that balance at 30 June then how can we ensure it’s correct?” he questioned.
Where an LRBA involves a property asset and there are repairs or maintenance happening at that property, it’s vital SMSF professionals are across the details or what that repair and maintenance is.
“We’re allowed to draw off the loan to repair the property or maintain it, but not improve it. We able to improve the asset provided that the improvement doesn’t change the characteristics of the loan,” Mr La Spada explained.
“So, if there’s features that have been added to the property or some type of repair or maintenance going on, then you need to across how it was facilitated and funded, because auditors are going to ask those questions.”
