SMSF’s are becoming more and more popular and many SMSF Trustees are looking to purchase real estate as part of the superannuation fund investment strategy.
There is a minefield of traps for unwary SMSF Trustees and non-compliance with the superannuation legislation can have catastrophic taxation consequences for SMSF’s and their members.
In this article we set out some tips and traps in relation to SMSF borrowing and the acquisition of assets by the superannuation fund, particularly real estate assets.
Although there are still very specific rules about the types of borrowing allowed by SMSF’s those rules were significantly relaxed in 2007.
Generally speaking, apart from a couple of limited exceptions that are not relevant for the purposes of this article, an SMSF can only borrow money to purchase an asset using a “limited recourse borrowing arrangement”.
In such borrowing arrangements the SMSF Trustee receives the “beneficial interest” in the purchased asset but the “legal ownership” of the asset is held on trust by another “holding trust” or what is sometimes called a “bare trust”.
The SMSF Trustee will have the right to acquire the legal ownership of the asset by making one or more payments in the future at which time the SMSF Trustee can require the Trustee of the Bare Trust to transfer the legal title of the asset to the Superannuation Trustee.
Limited Recourse Borrowing Arrangements (LRBA)
The method of borrowing allowed by the Superannuation Industry (Supervision) Act, 1993 (“the Act”) is quite specific. Under Sections 67A and 67B of the Act the Trustee of an SMSF is allowed to borrow on a limited recourse basis only for the purpose os acquiring a “single acquirable asset”.
An LRBA means that any recourse the lender has against the SMSF Trustee for default in payment of the LRBA is limited to the single fund asset.
Lenders can, however, legally demand an individual to provide personal guarantees against other personal assets as security for the loan but the other assets of the superannuation trust are protected from claims by the lender if there is a default under the loan.
An “acquirable asset” means an asset:
- which is not money (in any currency);
- which is not a prohibited investment of the Trustee under the Act or any other law; and
- if a collection of assets (e.g. shares), they have the same market value as each other and are identical to each other (See Sections 67A(3) and 67B of the Act regarding replacement assets).
Single Acquirable Asset
The asset must be held by a Bare Trustee for the SMSF Trustee and the Trustee must have a beneficial interest in the asset and be entitled to require its transfer after making one or more payments for the asset.
Note that the asset must be a “single acquirable asset”. The Australian Taxation Office (ATO) has recently stated that real property consisting of more than one title cannot be regarded as a “single acquirable asset”, and so each separate title must be the subject of a separate trust.
A “Bare Trust” is a Trust where the beneficiaries are absolutely entitled as against the Trustee and the Trustee has no active duties to perform.
A Bare Trustee can be anyone except the Super Fund Trustee. This is because a Trust relationship cannot come into existence where the Trustee is holding the trust property for itself.
Although there is nothing legally wrong with having individuals as the Bare Trustee it is strongly recommended to have a corporate Bare Trustee in place so that any deaths or movements in underlying membership of the fund will not affect the Bare Trustee’s property holdings.
What the borrowing can be used for
The use of the amount borrowed is limited to:-
- Acquisition of the asset; and
- expenses incurred in connection with the borrowing or acquisition, or in maintaining or repairing the asset (but not expenses incurred in improving the asset, e.g. extending a factory or extensively renovating a home or unit).
The borrowed moneys cannot be used to acquire non-fixtures for premises.
When purchasing real estate, who signs the Contract for Sale?
The Bare Trustee must sign the Contract as the legal purchaser. In the case of DKLR Holdings Co (No 2) Pty Limited v Commissioner of Stamp Duties (NSW) (1980) 1 NSWLR 510 it was held that double stamp duty may be payable where a contract makes reference to the trust.
Therefore no reference to the Bare Trustee’s capacity as the Trustee of the Bare Trust should be made in the Contract. The Title deed for the property will simply bear the name of the Bare Trustee as the registered proprietor of the property.
Accordingly, the Bare Trustee will need to keep accurate records of all necessary resolutions properly drafted and signed to prove what the Bare Trustee was doing. Generally, anything done by the Bare Trustee must be accompanied by minutes or resolutions authorising the Bare Trustee to do what is being done.
Declaration of Trust
The “Declaration of Trust” must comply with the Act and must also be acceptable to the Lender so it should include the following provisions:-
- that the contract for sale of the property/asset was between the vendor and the Bare Trustee as the apparent purchaser (and not the Super Fund Trustee);
- that all of the purchase money was provided by the Super Fund Trustee as the beneficial owner and its lender and none by the Bare Trustee;
- that the Bare Trustee is simply holding the property on Trust;
- that the only obligations of the Bare Trustee are to act on any request or direction from the Super Fund Trustee;
- a direction from the Super Fund that the Bare Trustee is not to transfer the property to the Super Fund Trustee until the last payment due to the lender of the loan has been paid;
- that the Bare Trustee must sign any documents relating to moneys provided by the Super Fund Trustee so that the Super Fund Trustee can provide the property as security to the lender.
If a Lender tries to insert the word “guarantee” in this clause, extreme care must be taken to ensure that the guarantee does not extend to other assets of the super fund as a failure to comply with this requirement may render the entire arrangement invalid under Section 67(4A) of the Act.
Dating the “Declaration of Trust” by the Bare Trustee
In New South Wales, the date of the Declaration of Trust by the Bare Trustee must be after the date of exhange of Contracts. If it is dated before the date of the Contract then double stamp duty may be payable.
Stamp Duty on the Declaration of Trust
Under Section 55 of the Duties Act, 1997 (NSW) concessional stamp duty of only $500.00 is chargeable on the Bare Trust Deed if the Commissioner for Stamp Duties is satisfied that the whole of the purchase price came from the Super Fund (and its Lender) and that the “apparent purchaser” exemption under Section 55 therefore applies.
When the Lender’s loan is repaid the Super Fund will call for the transfer of title from the Bare Trustee to the Trustee of the Super Fund.
To avoid full ad valorem stamp duty being payable on that transfer the SMSF will need to rely upon the above “apparent purchaser” exemption, which will have concessional stamp duty payable.
The SMSF needs to satisfy the Commissioner that the Bare Trustee was the “apparent purchaser” and that the Super Fund was the “real purchaser”. This is done with a Statutory Declaration (see below) which attaches a trail of documents to show how the money was supplied to the Bare Trustee.
The Statutory Declaration will need to attach bank statements showing money coming from the Super Fund’s bank account, copies of cheques to be linked to bank statements and loan documents.
As finding those records in the future could prove difficult it is very important to get the Declaration of Trust Deed stamped at the beginning of the process using the Statutory Declaration to the Commissioner.
When the time comes, the transfer of the property to the Trustee of the Super Fund will be stamped at a concessional rate provided the SMSF Trustee can produce the stamped Declaration of Trust Deed which created the Bare Trust.
Before entering into a “limited recourse borrowing arrangement”
Before the SMSF Trustee commits to a borrowing it should make sure of the following:-
- Compliance with the borrowing exemption in Section 67A is dependant upon the loan and security documentation complying with the Act so it is vital to ensure that the Lender’s documentation is compliant;
- You must ensure that the SMSF Deed or Rules permit borrowings of the type contemplated;
- You must ensure that the proposed arrangement is a genuine borrowing arrangement and not a disguised contribution and that the sole purpose provisions of the SMSF are not breached;
- Ensure that the Investment Strategy of the SMSF is adequate to deal with the arrangement. If it is not then the Investment Strategy will require amendment before the arrangement is entered into.
- Ensure that the asset to be acquired is one permitted under the Act and the rules of the SMSF, which is to be regarded as a “single asset”, and that any necessary taxation and other legislative consequences of the acquisition are considered. Taxation considerations may include Capital Gains Tax, tax on dividends of private companies, GST and Stamp Duty;
- The ATO has indicated that it will assess these arrangements carefully and with particular regard to the commerciality of loan arrangements;
- Ensure that the interest rates to be paid are commercially justifiable and that the arrangement is properly documented. Care should be taken especially where the Lender is a related party; and
- Guarantees of the loan arrangements should be carefully reviewed to ensure that they meet the requirement that the rights of the guarantor against the trustee are limited to the asset.
The following documents must be prepared in connection with the borrowing:-
- A Product Disclosure Statement (PDS) should be given to the SMSF Trustee and each member of the SMSF before the arrangement is agreed to. This document sets out in general terms the requirements of the Act in relation to the SMSF Trustee borrowing, the issues which should be taken into consideration by the SMSF Trustee and the members before deciding to enter into such an arrangement, the potential benefits and pitfalls of entering into such an arrangement and any associated costs and charges. Note the provisions of Section 1012DA of the Corporations Act, 2001 which provides that if a Trustee reasonably considers that the members already have all the information necessary to consider whether to enter into a proposed arrangement then it is unnecessary to provide them with a PDS. In view of the complexity and importance of this particular arrangement, however, it is recommended that a PDS be provided anyway;
- Minutes of a Meeting of the SMSF Trustee whereby it resolves to amend its Investment Strategy;
- Minutes of a Meeting of the SMSF Trustee whereby it resolves to enter into a limited recourse borrowing and a trust arrangement for the purposes of acquiring an asset on the terms provided by Sections 67A and 67B of the Act;
- Minutes of a Meeting of the custodian/bare trustee whereby it agrees to accept trustee status and to execute the Declaration of Trust tabled at the meeting;
- Declaration of Trust/Custodian Trust Deed for execution by the custodian/bare trustee; and
- A Statutory Declaration for execution by a director of both the Superannuation trust and the Custodian/Bare Trust before a Justice of the Peace/Solicitor regarding the Declaration of Trust.
It is very important to ensure that you retain copies of cheques and bank statements for annexure to the above Statutory Declaration.
If you are considering the purchase of real estate in your SMSF then contact Geoff Brazel at Brazel Moore Lawyers on (02) 4324 7699 for more information.