Superannuation Borrowing Rules – Bare Trusts explained Borrowing to fund investment property in your SMSF

SMSF regulations require that any property acquired with security (e.g. a mortgage) in place should be held in a bare trust, with the SMSF as the main of the trust. The SMSF will receive any rental income from tenants and pay interest to the lender. Once the loan is repaid, the legal ownership will be transferred to the of the SMSF. For property investment, the bare trust is simply the registered holder of the property until the loan is repaid. A separate bare trust must be set up for each title as it relates to the property you intend to use for investment purposes and which has security against it from a lender. What is a bare trust? Bare Trust means a simple trust. It is sometimes referred to as a holding trust. Bare trusts are often used where it is necessary to conceal the true owner or purchaser of the property (e.g. shares, land, businesses, etc) which is to become the subject of the bare trust. The bare trust custodian or trustee holds the legal ownership of the subject property for the express and absolute benefit of the true owner but the bare trust custodian has neither power nor discretion as to the trust property nor any active role in administering the trust property. The term “bare trust” is a shorthand term for a trust in which the custodian or trustee has no active duties. The custodian has a “bare” duty to transfer the land upon demand to the beneficiary or as directed by the beneficiary (for example, to a third party or the super fund). Bare trusts are commonly used in private and business structures. The importance of properly effecting and evidencing a bare trust is important:

 for stamp duty purposes, in obtaining the exemption for the transfer to a bare trust and distribution from one to a third party;  for land tax purposes, in relation to obtaining the principal place of residence exemption;  for CGT purposes, in relation to demonstrating that a beneficiary has an “absolute entitlement” to the underlying land;  for GST purposes, in relation to land held on bare trust for an entity conducting an enterprise; and  for superannuation purposes, in relation to land held on a “holding trust” (another name for a bare trust) for the purposes of the limited recourse borrowing rules.

10 Common mistakes.

While on the surface of it, a bare trust looks straightforward, there are often mistakes made in the set up and operation of a bare trust, particularly where there is a Limited Recourse Borrowing Arrangement in place. As accountants, we have seen many of these errors, even accountants sometimes don’t get it right and prepare tax returns and accounts for the bare trust. We’ve outlined the key ones below that you should seek advice on before embarking on adding property to your SMSF: 1. Timing of creating entities and signing the : This can be a big mistake and costly. If it is done in the wrong order it can give rise to double stamp duty or an ineffective arrangement that does not comply with the Superannuation Industry Supervision (SIS) guidelines . The law is that when you create a trust you must create it over an asset. Hence in there is a settlement amount of say $10.00. A bare trust is no different. You cannot create a bare trust without putting it over an asset of some description. The first step is to create the bare trust then sign and date the contract accordingly. In different states, different stamp duty laws apply and hence the timing in different states varies. They determine the order in which the trust is created and when the contract can be signed (dated).

2. Wrong Name on the contract: You cannot sign a contract without knowing who the purchaser will be. Many people put either “To be advised” , or a “name with and/or Nominee” or the super fund’s name or the super fund’s trustee’s name on the contract. All of these are wrong. The purchaser must be the bare trust custodian’s name. Any of the above wrong purchaser names will result in double stamp duty. It is preferable that a company be the bare trust custodian and this entity’s name needs to be on the contract. Again each state is different. In NSW trust’s are not recognised. In QLD they are. So in QLD you should say ABC Pty Ltd as bare trust custodian of the ABC Bare Trust (or using names as applicable to your entities.) No mention is made of the super fund. In NSW you would say ABC Pty Ltd.

3. Getting advice too late: Many people buying property for their SMSF often buy first and seek advice later. The downside is that they often do not understand the rules and requirements of owning property within an SMSF, which can create problems and costs (e.g. stamp duty) when it comes to selling the property or managing income, expenses and other SMSF compliance issues down the track. See the above on having the wrong purchasers name on the contract. It is simply not correct to form an entity

after the date of the contract and then try and change the contract. The timing will be wrong.

4. Individual or corporate trustee: It is acceptable to have individuals as trustee of your super fund and as bare trust custodians. However it is fraught with problems. Remember this is the name that appears on your title. Where individuals are the advising that the property is not held beneficially can be a problem with third parties like a trustee in bankruptcy, a creditor, a bank, ATO, OSR for Land Tax etc. All able to be done but it can create issues and we have seen trustees . Our recent factsheet on the type of trustee required for your SMSF outlines the pros and cons of each type of trustee. Getting this right early ensures you can protect your investments properly from the outset.

5. Borrowing with little or no deposit: Borrowing to fund a property within your SMSF requires that you set up a formal arrangement for any security on the property. Equally while many people may understand the concept of negative gearing, many don’t understand that it doesn’t work effectively in a low tax environment such as superannuation. Also if you are looking to borrow in your super fund then a lender may be nervous about where the additional repayments will come from if the rents do not cover the repayment. In fact procuring a loan may prove difficult if not impossible in these circumstances.

6. Buying off the plan: This is similar to the above point. What happens if prices go down before settlement. When buying off the plan a purchaser will not have any finance approved until closer to settlement. What happens if the purchaser cannot obtain a loan, the contract will be in default.

7. Property title: Investment properties purchased under a LRBA usually require separate titles for each property or title if they have the potential to be sold separately e.g. if an apartment and car space are on separate titles.

8. Use borrowings properly: Often trustees don’t understand that borrowings in an SMSF can’t be used in the same way finance can be used personally or in a family trust. Trustees must understand that any borrowings must be used for purchasing a new property, not renovating properties in their super fund. Properties held in LBRA can not be significantly changed nor can the cost of doing so be used as a tax deduction.

9. Income, expenses & deductions: The bare trust trustee should hold the title of the property and nothing else; any rental income, GST payments, land tax and other costs are made and received by the fund trustee, thus there is no requirement for separate bank accounts for the bare trust. All expenses and deductions claimed for the investment property should be included as part of the SMSF’s annual tax return, rather than submitting a return for the bare trust. A key advantage of the bare trust is that it is not a reportable entity and does not require an ABN or TFN.

10. Separate the lender from the bare trustee: It’s not advisable that the lender act as the bare trust trustee in a bare trust for several reasons. The main one is that there is the potential for conflict between the rights over the property and the obligations a bare trust trustee has to report appropriately. We are aware that the Commonwealth Bank creates its own bare trust Custodian. We suggest this is not done for the above reasons.

BBX Implications:

There is no issue with a super fund having a separate BBX account, holding BBX dollars as assets dollars (they are treated as assets and not money) or purchasing property using BBX dollars as part of the deposit. It is also perfectly OK using the bare trust arrangement that the super fund borrows to fund a property purchase. The sole purpose of a super fund is to create a retirement income for its members. This can be part of the investment strategy of the fund and BBX can assist with achieving that aim. The issue is how to get the BBX dollars into your superannuation fund. From 1st July 2017 the amounts that are contributed into super are capped or limited to: a) $25,000 per annum for each member as a concessional contribution (tax deductible to the member or member’s employer. b) $100,000 per annum for each member as a non concessional contribution (personal money not tax deductible). A bring forward rule of 3 years applies to allow you to bring forward 3 future years and hence contribute $300,000 in one year. For members of BBX that wish to purchase property in the SMSF you need to use a combination of the above to both maximise your tax deductions outside super and allow the deposit and other components to be placed into your super. The process we use that is effective it to maximise your concessional/ tax deductible components first and then use the balance of your non concessional components. Remember you cannot exceed the above caps. We generally do this as “in specie” (in kind) contributions as the deposit is usually paid direct from the members BBX account. As long as the super fund records the entries correctly. Everyone’s personal situation is different and the above is only a guide of what can be done. Persons seeking to use their BBX dollars this way need to obtain personal advice that takes into account their own personal situation. If a new superannuation is to be created ASIC requires that the person obtain financial advice on whether such an action suits their individual needs.