Practitioners cautioned on using LRBA alternatives
While unrelated unit trusts may seem a good alternative to limited recourse borrowing, given their investment flexibility, there are various traps SMSF practitioners should be aware of, according to Heffron SMSF Solutions.
Speaking at a breakfast hosted by the SMSF Association earlier this week, Heffron SMSF Solutions technical services manager Leigh Mansell explained that given the Financial System Inquiry has recommended a ban on LRBAs, some pracitioners are looking to unrelated unit trusts as a possible alternative.
However, if a member of an SMSF is in control of an unrelated unit trust, the SMSF cannot invest in that unit trust since it will be considered an in-house asset, Ms Mansell said.
“One of the problems with these unit trusts is you can’t control it and so you need to have a bit of an exit strategy or some sort of agreement to terminate if it all goes horribly wrong,” she said.
Lawyers often establish trusts with at least three separate parties because it allows one of the parties to get out of the trust if they wish to do so without impacting the other members too significantly.
“If, [on the other hand,] you’re dealing with two people and one of them wants out, then how does the other get out?” she said.
“They’re going to have to buy the other [party’s] units but then they will control the trust and therefore have an in-house asset – you’ll then have a dirty trust.”
Setting up trusts with at least a few unit holders is therefore important, said Ms Mansell.
She emphasised that there are a number of control issues that SMSF practitioners and their clients need to be aware of.
“[For example] if me and the other trust members may not have more than 50 per cent but we may be able to push the trustee around,” she said.
“You also need to consider whether the trust deed gives the group the power to remove or appoint a new trustee for the unit trust.”
Any of the alternatives to using limited recourse borrowing arrangements each have their advantages and disadvantages, she said.
“You need to make sure you go into a unit trust with your eyes open and ensure you’ve got some sort of exit strategy from the get-go.