Six years of LRBAs - some issues to keep in mind

It has been six years since limited recourse borrowing arrangements (LRBAs) were introduced for self-managed super funds (SMSFs) to acquire residential or commercial properties, and so a number of issues may now require SMSF trustee review.

Rent

Rent is particularly important for commercial property with a related party tenant. (In-house asset rules would be triggered if a related party tenant occupies or uses a residential property.)

The SIS Act provides in s109 that when related parties deal with the fund that it must be at arm's length.

The rent should be no more favourable to the tenant than if the landlord was an unrelated party.

It is also worth noting that an inflated rent which is above market value would also fail to satisfy the arm's-length test and could even result in an assessment that deemed contributions are being made to the fund.

Refinancing the existing loan

If you are looking to refinance the loan made to the fund trustee with another financial institution, many banks require a certificate of compliance.

This is a legal review of the transaction documents and a statement from your superannuation lawyer that the transaction complied with the SIS Act.

In addition to this, some lenders have a compulsory in-house Holding Trustee or Custodian that is mandatory for you to use when establishing a LRBA.

If your current lender has an in-house Holding Trustee as part of your LRBA and you are refinancing with a different lender, you will need to arrange for a new Holding Trustee to be established and appointed, since the original bank's in-house Holding Trustee will no longer be used after the refinance.

After that appointment you will need to organise for the transfer of title for the property from the previous (in-house) Holding Trustee to the new Holding Trustee.

If the loan is from a related party lender (for instance a member), they may wish at some stage to change the terms of the loan.

Depending on the nature of the change required this too might result in what would be considered a refinance of the original loan.

Unwinding the LRBA when the loan has been repaid

It is important to stay aware of the balance of the loan. When it has been paid out, the property must be transferred from the Holding Trustee to the Fund Trustee as soon as practicable.

If there are no longer any moneys owing on the property and it remains in the Holding Trust, it is no longer considered to be part of the LRBA. Without the LRBA exemption, the holding trust now becomes a related party trust and you will encounter in-house asset test issues.

Insurance

If an SMSF uses limited recourse borrowing for a property purchase, then it must be decided whether the trustee or the holding trustee takes out the property insurance and landlord's protection insurance.

The final answer is that both the trustee and the holding trustee have an insurable interest in the land, and both are eligible to be the owner of the property insurance and landlord's protection insurance over the property.

The trustee is entitled to take out insurances for the property, as the fund is liable under the loan and is also absolutely entitled to the benefit of the property.

As the fund is ultimately the party that is detrimentally affected should anything happen to the property, the trustee should ensure that the fund is able to claim for any damage that might occur.

The holding trustee is the legal owner of the land and is entitled to insure the property against damage, and likewise for landlord insurance.

Some lenders may also insist that the registered proprietor of the property holds an insurance policy for the property.

But, it is important to keep in mind the nature of the arrangement between the SMSF trustee and holding trustee, should insurance be taken out by the holding trustee.

As the holding trustee is a bare trustee, it must make sure that it does not take any action unless it is directed to do so by the fund trustee, who is absolutely entitled to the property.

This direction by the fund trustee should be done formally and in writing, and confirmed by the holding trustee executing minutes to confirm this action.

The final answer is that both the holding trustee and the SMSF trustee have an insurable interest in the land and that both are eligible to be the owner of the property insurance and landlord's protection insurance over the property.

In both instances all amounts payable in respect of the insurance should be paid by the fund trustee. Obviously the holding trustee must hold any policy proceeds on trust for the SMSF.

From a purely administrative position it would be easier for the SMSF to hold the insurances to avoid the constant but mandatory interplay between the SMSF and its bare trustee, the holding trustee.

But the insurance company may have its own requirements, as might the fund's lender.

Discuss the issue with the fund's broker and check with the lender for any requirements. The need for this insurance should also be considered by the fund's accountant or financial planner.

SMSF deeds must be up-to-date

Rapidly changing laws for SMSFs are placing trustees in danger of having out-of-date deeds which will render the SMSF unable to do what the members are needing or wanting to do.

Further clarification by the Australian Taxation Office of certain issues relating to limited recourse borrowing arrangements should be incorporated into the governing rules.

Given this, it is vital to ensure that the trust deed accommodates all these developments to avoid potential legal and tax problems and other associated penalties.

A wide-ranging number of areas other than the SIS Act can affect the operation of your SMSF trust deed, including changes to Federal and State legislation and regulations as well as pronouncements by the ATO and ASIC.

If the deed was last updated before 2010, it may not permit the fund to engage in limited recourse borrowing under s67A arrangements.

If your deed was last updated before 2007, it probably does not permit payment of transition-to-retirement pensions.

If the deed was last updated before 2008, it may not permit the making of SMSF-specific Binding Death Benefit Nominations.

A number of significant changes to superannuation will occur or are currently proposed to happen in 2013.

Michael Hallinan is special counsel, superannuation at Townsends Business & Corporate Lawyers.