SMSF borrowing requires timing and precision that would be unexpected for someone buying an investment property. The investment property in a DIY structure is not held in the borrower’s name but by the trust that administers the super fund.
Before engaging in a limited recourse borrowing, the superannuation trust deed may need to be amended before the borrowing can take place. Also, investment and gearing strategies may need to be reviewed.
There are a number of names used to describe a loan made to an SMSF, including holding trust deed, custodial deed and bare trust. The most common name used now is limited recourse borrowing arrangement or LRBA. This term describes the working of the loan because if the loan defaults, the lender's rights are limited to the asset held in the separate trust, meaning there is no recourse to the other assets held in the SMSF.
A typical borrowing by an SMSF has the following steps and the order of these steps is important to minimise any difficulties in completing the transaction:
- Determine (often with the help of the fund’s accountant or financial planner) that borrowing would be an appropriate strategy to leverage investment
- Check the SMSF trust deed to ensure trustees have power to borrow, grant security & allow assets to be held by custodians/nominees for the trustee (if not, amend the trust deed)
- Check the SMSF investment strategy to ensure it allows for the acquisition of the investment asset and permits borrowing for that purpose (if not, amend the investment strategy)
- Source the asset for purchase, negotiate the price and reach an agreement with the vendor
- Finalise borrowing arrangements with the lender including in-principal loan approval
- Determine who is to be the custodian – if a new company, purchase the new company
- Custodian resolves in writing to act as custodian for the super fund trustee in the purchase of the asset
- SMSF trustee resolves in writing to purchase the asset and to appoint the custodian to act for the super fund trustee as bare trustee of the bare trust
- Sign the bare trust deed (Qld, SA, NT)
- Signing of the purchase contract by the custodian (note: not SMSF trustee)
- SMSF trustee provides all the deposit money for the purchase (should come directly from the super fund’s account. If the deposit initially comes from the pocket of the SMSF trustee, then this deposit amount should be paid into the SMSF as a superannuation contribution within several weeks and notation made to that effect in the SMSF’s records
- Custodian and SMSF trustee sign the bare trust deed (NSW, ACT, VIC, TAS, WA)
- SMSF trustee signs all loan documents with the lender (note: SMSF trustee is the borrower)
- Purchase of the asset is completed using only money coming from the SMSF’s account or from the loan by the lender
- The bare trust deed is submitted to the NSW Office of State Revenue for payment of stamp duty.
- When the loan is eventually repaid the asset can be transferred from the custodian to the super fund trustee for nominal stamp duty provided the bare trust deed has been stamped already.
This style of lending will be new to many trustees and caution should be taken to ensure the gearing of property inside a DIY fund is in the interests of all fund members.
After the loan is repaid – unwinding the LRBA – things to consider:
Unwinding an LRBA involves repaying the borrowing by which the Acquired Property was acquired and then transferring the Acquired Property to the SMSF.
Unwinding an LRBA therefore raises issues as to whether the transfer of the Acquired Property is a CGT Event or a taxable supply and whether the transfer is entitled to concessional transfer duty treatment.
Additionally, unwinding the LRBA involves the registration of the transfer form and the payment of various land titles office registration fees.
Peter Townsend BA LLB FCLA FAICD is Managing Director of SUPERCentral, and a business lawyer with over 30 years’ experience in providing legal advice to participants in the financial planning and securities industries.
Please note that these comments are for your consideration only and are provided to assist you in deciding whether to proceed to obtain a formal opinion on the issue. These comments cannot be relied upon by either you or any of your clients until and unless we issue that formal opinion.