New legislation clarifies tax issues relating to SMSF Limited Recourse Borrowing Arrangements

Self managed super fundsBy Rodney Commins, Patterson Houen & Commins, Lawyers, Sydney

In the sometimes barren world of tax planning, there occasionally falls a shard of sunlight. One such is the draft legislation released January this year relating to limited recourse borrowing arrangements (“LRBA”s) of self-managed superannuation funds (“SMSF”s).

Most people with any familiarity with LRBAs understand that the asset acquired through the arrangements is acquired not by the SMSF trustee, but by a separate trustee for the SMSF. While this trustee is commonly referred to as a bare trustee, the Australian Taxation Office (“ATO”) has expressed a view that such arrangements do not necessarily constitute a bare trust, but rather a “holding trust”. The consequence of this view is that, although a bare/holding trust is necessary to comply with LRBA requirements under the Superannuation Industry (Supervision) Act 1993, taxation issues could arise, such as:

  • Whether or not a bare/holding trust has to lodge a separate income tax return. No separate income tax return is required for a “transparent trust”, that is, a trust in which the beneficiary has an absolute indefeasible entitlement to the capital and income of the trust but, given the ATO’s view relating to the bare trust arrangements, it is arguable that they do not constitute a “transparent trust”.
  • Interest deductions. Normally, where one party buys an asset for a second party, the first party cannot claim an interest deduction on any loan raised in connection with that acquisition against income derived from the asset by the second party. Query then the deductibility of interest paid by the SMSF on a LRBA.
  • Capital Gains Tax. A transfer from the bare trustee to the SMSF trustee on payment of the final instalment under the LRBA, if the ATO maintains its view, would mean that the SMSF trustee was not absolutely entitled to the bare trust asset and CGT event E2 or E5 could occur.
  • Dividends, etc . Other issues relate to any dividends and franking credits relating to shares acquired pursuant to LRBAs.

The clouds of uncertainty outlined above will be banished by the draft legislation which in effect will provide that the SMSF trustee itself will be treated as the owner of the asset acquired in the name of the bare trustee through the LRBA. In other words, the bare trust will be ignored in relation to the ultimate ownership of the relevant asset and the acquisition and holding arrangements will be transparent, at least for income tax and capital gains tax purposes. The changes are slated to operate retrospectively to 2007, the year when the “instalment warrants” now referred to as limited recourse borrowing arrangements for SMSFs were introduced.

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