Townsends Business & Corporate Lawyers' Peter Townsend outlines some of the do's and don'ts for maintaining a bare trust in a LRBA.
Most limited recourse borrowing arrangements (LRBAs) by self-managed super funds are established using a bare trust and it is important to ensure that the status of the trust is not affected by simple (and avoidable) mistakes that lead to negative consequences for the fund.
While it is not a requirement that a LRBA be established as a bare trust (the ATO says it requires a 'holding trust') it is usually the preferred option as it avoids the adverse income tax, Capital Gains Tax (CGT) and Goods and Services Tax (GST) implications which would otherwise be encountered.
To put it simply, a bare trust means that the bare trustee is not permitted to do anything unless it is at the direction of the beneficiary, the super fund trustee.
We have outlined below a few simple do's and don'ts to assist with maintaining the bare trust status for a LRBA.
Do – ensure all payments are made and received by the fund trustee
The bare trustee should simply hold title of the property and nothing more.
Accordingly, it does not require its own bank account, and instead all payments should be made and received by the fund trustee. This includes rental income, GST payments, land tax and any other costs incurred for the property.
Do – ensure a formal direction is given to lease the property
A formal direction should be made by the fund directing the bare trustee to take any specific action over the property. This is particularly relevant where the fund trustee wants to lease the acquired property to a tenant.
A separate direction should be given for each new lease the bare trustee must sign, rather than the fund providing a general direction for it to generally lease the property during the lifespan of the LRBA.
Use of a general direction would be likely to be seen as the creation of a duty and it would be highly likely that such a duty would erode the bare trust by providing the bare trustee with the discretion to act on its own accordance. This is fatal to the very existence of a bare trust.
Don't – have the bare trust complete a separate tax return
An advantage of a bare trust is that it is not a reportable entity for taxation and does not need to have its own ABN or TFN. All expenses and deductions claimed for the property are generally included in the fund's annual return, so the bare trust should not lodge its own, separate return.
Don't – have the lender also act as the bare trustee
It is not recommended that the lender act as the bare trustee in a bare trust. The rights over the property as the lender would likely conflict with the obligations as bare trustee and would erode the bare trust status.
If the bare trust status is eroded during the lifespan of the LRBA, there may be reporting implications as well as potential CGT implications on the transfer of the property to the SMSF trustee once the loan has been repaid.
Peter Townsend is the principal of Townsends Business & Corporate Lawyers.
Originally published by SMSF Essentials.
