The Tax and Superannuation Laws Amendment (2015 Measures No. 2) Act 2015 (CT) received Royal Assent on 16 September 2015. It was designed to provide ‘income tax look-through treatment for installment warrants, installment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds’.
On its face, it is good news. However, there’s a sting in the tail that advisers must be aware of.
Naturally, where the trustee of a regulated superannuation fund (which of course basically all SMSF are) wishes to borrow, it generally can’t own the asset directly. Rather, in order to be excepted from the prohibition on borrowing, the asset must be held on trust for the trustee of the SMSF. In this article I’ll refer to this trust as a ‘holding trust’.
Often people refer to the holding trust as a bare trust, however, there’s a huge degree of variation in how different document providers draft their holding trust deeds. In the same way that ‘oils ain’t oils’, it’s also true that ‘holding trust deeds ain’t holding trust deeds’.
There are many holding trust deeds with so many extra provisions. For such hold trusts, it’s extremely doubtful whether the trust they document constitute bare trusts.
The ATO, for their part, is sceptical as to whether any holding trust that is used as part of an SMSF borrowing arrangement is ever a bare trust. This is due to the mortgage over the asset that a lender will typically impose. This raises the question of what happens when the loan is repaid and any mortgage is repaid: then can the holding trust be a bare trust?
Industry practice has been to ‘look through’ the holding trust and simply treat it as being directly an asset of the SMSF for taxation purposes.
However, this raises the critical question of whether for taxation purposes it is actually correct to do this, or whether the holding trust should be treated as a separate trust. If it should be treated as a separate trust then it could make SMSF borrowings very inefficient because an additional annual income tax return would be needed, a CGT event might result when the asset is transferred at the end of the borrowing when the asset is transferred from the trustee of the holding trust to the trustee of the SMSF, as well as other issues.
What the new law provides
The Tax and Superannuation Laws Amendment (2015 Measures No. 2) Act 2015 (Cth) has clarified that for an investor that is a trustee of a regulated superannuation fund, look-through treatment is provided in respect of assets acquired under a limited recourse borrowing arrangement that satisfies the requirements of the Superannuation Industry (Supervision) Act 1993 (Cth). In other words, there is now legislation expressly providing that the holding trust is effectively ignored and anything that happens to or results from being the owner of the asset, such as receiving franked dividends, affects the investor (a trustee of the regulated superannuation fund) and not the trustee of the holding trust.
Naturally, this is good news. The new law suggests that assets can be bought via holding trusts and then left in the holding trusts and a complete look through approach can be taken. This is very reassuring for some who might be concerned that the original purchase might have been poorly structured and as a result any subsequent transfer from the trustee of the holding trust to the trustee of the SMSF might attract full ‘ad valorem’ stamp duty. This is often the case, for example, for Victorian real estate where the deposit was not paid from a bank account in the name of the SMSF.
Where’s the sting?
I did mention that there’s a sting in the tail and here it is: consider the in-house asset rules. Strictly speaking, the asset that the SMSF trustee has is an interest in the holding trust. Therefore, this holding trust can be seen as a related trust, and an investment in a related trust typically constitutes an in-house asset.
SMSF trustees typically are not allowed to have more than 5% of their assets in in-house assets. To counteract this in-house asset concern, the legislature added an exception to the in-house asset rules. See s 71(8) of the Superannuation Industry (Supervision) Act 1993 (Cth). Section 71(8) broadly provides that an investment in a related trust that was made in order to meet the LRBA requirement does not constitute an in-house asset.
Accordingly, there is specific legislation that prevents a holding trust from causing issues from an in-house assets point of view.
When the loan is paid off, s 71(8) becomes ineffective, and the value of the interest in the holding trust (ie, typically the value of the underlying asset) then — on its face — becomes an in-house asset.
To counteract this concern, the ATO have altered the legislation with Self Managed Superannuation Funds (Limited Recourse Borrowing Arrangements – In-house Asset Exclusion) Determination 2014. This provides that after the loan is paid off, the interest in the holding trust is still excepted from constituting an in-house asset.
This is not a perfect fix though. The exception from the in-house asset rules will only apply if the underlying asset is not fundamentally altered. This is still the case even after the loan is paid off. Accordingly, if an SMSF trustee wants to: (1) borrow to acquire an asset; (2) pay off the loan; and (3) then subdivide the asset; it must insert a step between (2) and (3) (ie, (2A)), namely, transfer the asset from the trustee of the holding trust to the trustee of the SMSF. Failure to do so will mean that the interest in the holding trust, once the underlying asset is fundamentally altered (eg, subdivided), will constitute an in house asset.
Accordingly, at the end of the borrowing arrangement, SMSF trustees must be prepared to transfer the asset from the trustee of the holding trust to the trustee of the SMSF.
This trap has been around some time and the new law (which is relevant to taxation) does not help cure it.
The new law is great: it clarifies that holding trusts are eligible for look through taxation treatment. However, when entering into an SMSF borrowing arrangement, it is still important to plan for an eventual transfer from the trustee of the holding trust to the trustee of the SMSF.
If you would like to know more about how we may be able to help you plan for your future, call on 1300 99 77 34 or email your inquiry to FinancialOptions@chan-naylor.com.au for a complementary initial consultation.
Source – Bryce Figot – DBA Lawyers
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