When an SMSF acquires an investment using a limited recourse borrowing arrangement (LRBA), several set-up costs are usually incurred. For example, costs to incorporate a company that will act as the custodian or bare trustee, responsible for holding the legal title for the investment, as well as legal fees to document that the custodian/bare trustee is holding the investment for the benefit of the super fund. These are all costs associated with the fund’s acquisition of the geared investment.
This is why the super fund needs to be invoiced and pay for all associated costs. Since 1 July 2018, the concept of what qualifies as non-arm’s length income was expanded and includes situations where in gaining or producing income, the fund incurs less expenditure (including no expenditure) than would otherwise have been expected if the parties had been dealing on an arm’s length basis. This includes expenditure incurred to acquire an asset (including associated financing costs).
If a super fund member or other entity in the family group has been invoiced and paid for the LRBA set-up costs instead and has not been promptly reimbursed by the super fund, the fund may have non-arm’s length expenditure in respect of the investment acquired under the LRBA.
This may cause any income derived from the geared investment (including any capital gains) to be classified as non-arm’s length income and taxed at 45 per cent. As the shortfall in costs relates to expenses incurred in acquiring a specific investment, there is no limit imposed on the amount of additional tax payable.
Alternatively, if the fund was invoiced but that invoice was paid by the member or other entity and not reimbursed by the super fund, the cost will be treated as a contribution to super and tested against the member’s contribution caps.
Costs to incorporate the custodian/bare trustee company and document the custodian/bare trust arrangement will generally not be deductible to the super fund as they are expenses of a capital nature. SMSFs generally cannot use the “black hole” provisions, so these costs would be added to the cost base of the underlying asset.
Too often I see bare trust and it’s company costs included as “borrowing costs” and amortised as a tax deduction over 5 years.
The ATO has stated that LRBAs set up costs are bit borrowing costs and not deductible.
I disagree that the cost of setting up the required custodial trustee is a capital item. It does not part of the purchase of the asset, it is a Borrowing Cost imposed by legislation and would or should be a deductible expense.