As certain SMSF LRBAs reach completion, many are unsure how the arrangement should finish. There are a number of steps involved in weighing up options and strategy, as well as in documenting and carrying out the process.
Note that this article deals with the situation of where a borrowing has been paid off and the asset is being retained within the SMSF. If the situation is different (eg, the SMSF trustee is selling the asset to a third party), different considerations will apply.
When is a limited recourse borrowing arrangement ready to be unwound?
A core feature of an LRBA is that the SMSF trustee borrows to acquire an asset that is held on trust. The trust is often referred to as a "bare trust". While not all such trusts are technically bare trusts, the term bare trust will be used in this article for the sake of simplicity.
Some further core features of LRBAs are that the SMSF trustee has a beneficial interest in the asset, and has the right to acquire legal ownership after making one or more payments. An LRBA is therefore completed when the borrowing of money is extinguished (that is, when the loan is paid off). Once this happens, there is no borrowing being maintained. What is left is an asset being held on trust for the trustee.
At this stage, there is a choice as to whether to transfer the asset into the name of the SMSF trustee.
What costs are involved in transferring to the SMSF trustee?
There are likely to be transaction and administrative costs in transferring the asset to the SMSF trustee. If the asset is real estate, there will be a cost in conveyancing.
Then there is the question of whether stamp duty is payable on any transfer to the SMSF trustee. If the initial transaction was handled and documented properly (including the payment of the deposit), there is a stamp duty exemption in most jurisdictions. While some might think the stamp duty exemption should be a simple matter because the SMSF trustee has a ‘beneficial interest’ in the asset, the provisions in each jurisdiction are usually more complex in their requirements. Most exemptions have substantial procedures associated with them (eg, statutory declarations, documentary evidence, etc). It is recommended that SMSF trustees and advisers speak to a stamp duty expert in the jurisdiction in advance of any transfer.
Is it better to transfer to the SMSF trustee?
On the one hand, because of an ATO legislative instrument that commenced in April this year, the asset can be left in the bare trust without giving rise to an in-house asset. This will probably mean a saving on costs and hassle in the short and medium term.
However, if the end goal is to transfer the asset in specie to the members (say, upon the death of a member), it may be better to transfer to the SMSF trustee sooner. Given the documents needed for a stamp duty exemption, possibly waiting many years to do this could mean the crucial evidence is lost, forgotten or difficult to access.
Additionally, the conservative view of the current law is that if the SMSF trustee wants to change or improve the asset such that it becomes a fundamentally different asset (for example, by subdividing land or by converting residential land into commercial), the asset needs to first be transferred to the SMSF trustee.
How is the arrangement unwound?
If it is desired or necessary to transfer to the SMSF trustee, documentary evidence should be obtained from the lender that the loan is no longer outstanding. Any mortgage should also be removed.
Then, ‘getting out’ of the bare trust will in many ways mirror how the asset ‘got in’. That is, the procedure will depend on what the bare trust document (typically a deed) states. If there is a special procedure to follow in order to transfer the asset out, that procedure should be adhered to. Otherwise, the bare trust ‘rules’ may essentially say that the bare trustee will act on the direction of the SMSF trustee. If this is the case, the relevant documents may be a resolution to wind up the arrangement and transfer the asset, a direction to the bare trustee to do this and a resolution by the bare trustee to comply with the direction. Care should be taken to properly document this process, especially so that any audit shows that the relevant requirements have been satisfied.
A lawyer will typically be needed to handle conveyancing (if the asset is real estate).
Ideally, most LRBAs will have had the bare trust being treated as ‘part of the SMSF’ for tax purposes. In this way, any transfer to the SMSF trustee is simply a transfer ‘within’ a tax entity (the SMSF). This allows the transfer to be a non-event under the capital gains tax provisions (see, for example, Income Tax Assessment Act 1997 ss.104-55(1), 104-60(1) and 960-100(2).
On the other hand, the above process may be significantly more complex if the bare trust itself has been treated as a tax entity. Expert tax advice is recommended in this case.
Additionally, once the asset is transferred, related documents such as leases may have to be updated to reflect the new legal owner of the property (the SMSF trustee).
David Oon, lawyer, DBA Lawyers