The growing number of self-managed super fund (SMSF) trustees being advised to enter into highly geared limited recourse borrowing (LRB) arrangements in order to purchase assets for commercial use has been raising concern.
Tria Investment Partners managing partner Andrew Baker raised the flag in an article in which he used a hypothetical example of an industry fund member with $500,000 who geared up a newly established SMSF to purchase a $2 million crane for his company.
The crane was then leased back to the individual's business, with the revenue generated by the crane flowing to the SMSF via a trust.
According to Baker, the strategy would not technically contravene any of the following:
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The sole purpose test;
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SMSF investment strategy requirements; and
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The general anti-avoidance rule for income tax.
He said that after attending a number of SMSF seminars, he believed the example was not an unfair representation of some of the propositions being touted to trustees – and such propositions could lead to a potential industry disaster down the line.
"It's a widespread concern within the industry that the combination of high levels of gearing and 'exotic' assets or residential property assets will at some point result in big losses," Baker said.
"Quite frankly, if you look at the history of the industry, many of the industry's disasters have resulted from that combination," he said.
SMSF Professionals' Association of Australia (SPAA) technical manager Peter Burgess said that although there were definitely concerns regarding the breach of the sole purpose and in-house assets tests in relation to the crane example, he did not agree with Baker's suggestion that the use of these types of strategies was spreading.
He also said many of the issues involving high-level gearing and related party borrowing in SMSFs were largely addressed during the Cooper Review.
"We're not seeing a lot of this behaviour – there's a lot of talk about it," Burgess said.
"We [SPAA] haven't gone as far as to say there should be a legislative change or a limit proposed on LRBs, but it's certainly something that needs to be [watched]," he said.
Baker said the United Kingdom's self-invested personal pension (SIPP) regulatory regime had already set a precedent for the Australian SMSF sector to adopt.
SIPPs have "considerable flexibility in terms of what they can invest in" and provide the concept of 'taxable property', which comes with a punitive tax rate of 40 per cent, he said.
Multiport technical services director Philip La Greca said strategies like the one Baker outlined may occur because there is uncertainty as to whether LRBs should be classed as a retail product, and therefore fall under mandatory financial advice requirements.
"I think the Government is already leaning towards that approach, but they haven't got the law finalised," he said.
"If the regulations don't work, then yes, maybe they have to take another step," La Greca said.
