Threshold poses ‘brutal’ consequences for LRBAs, illiquid assets
The proposed $3 million threshold could see some SMSFs forced to liquidate large lumpy assets such as real estate for practical reasons, warns an SMSF lawyer.
Speaking in a recent webinar, DBA Lawyers special counsel Bryce Figot said given the measure is essentially a tax on unrealised gains based on the proposed methodology for the earnings calculation, it could have significant impacts on illiquid assets in higher balance funds.
Mr Figot explained if SMSF clients have large, lumpy illiquid assets such as real estate that also has low yields, this measure could create difficulties for the fund.
“The government isn’t saying that they’re trying to force SMSFs to liquidate residential real estate, but that could be the practical implications of this,” Mr Figot warned.
SMSF members with certain types of limited recourse borrowing arrangements (LRBAs) could also be impacted by the proposed $3 million threshold, even though the actual equity in the fund may be below $3 million, he added.
Mr Figot gave the example of Jenny, who had a total super balance of $2 million all in cash. Jenny is the sole member of the SMSF.
Jenny then borrows $4 million under a related-party LRBA in order to buy real estate for $6 million.
“If the lender is an associate under ITAA 1936 s 318(3) or Jenny has satisfied certain conditions of release, her total super balance is now $6 million just by engaging in the borrowing arrangement,” he stated.
“She’s now well within that tax net.”
Mr Figot gave another example of how members could unexpectedly be captured under the proposed threshold.
“Imagine Jenny borrows from an unrelated party instead and she’s only 40. Suddenly she’s horribly injured to the point where she is permanently incapacitated. From one day to the next she suddenly jumps into this regime,” he warned.
“Isn’t that brutal, that just by being permanently incapacitated and having an LRBA means your total super balance could just jump up significantly. I’d say that’s an unintended consequence.”