On 19 January 2015, the Government released Tax and Superannuation Laws Amendment (2015 Measures No. 2) Bill 2015: Instalment Warrants exposure draft legislation (ED) to amend income tax law to provide “look-through” treatment for instalment warrants, instalment receipts and superannuation funds that invest in assets using a Limited Recourse Borrowing Arrangement (LRBA).
SMSF LRBA Exception
The Superannuation Industry (Supervision) Act 1993 (SIS Act) prohibits trustees of superannuation funds from borrowing subject to limited exceptions. One of the exceptions is section 67A of the SIS Act that permits superannuation fund trustees to borrow money on a limited recourse basis using a trust arrangement.
Bare Trust v Holding Trust
One of the technical issues that has arisen in this area is the nature of the trust arrangement created by the LRBA. The issue is important because of the flow on tax and stamp duty implications that would arise if title to the asset is subsequently transferred from the custodian to the superannuation trustee.
The SMSF industry has referred to the trust arrangement as a bare trust with a custodian being the bare trustee. However, the ATO refers to the LRBA trust as a holding trust and has stated in NTLG Minutes of September 2010 that a LRBA trust arrangement is not strictly a bare trust.
The true character of the relationship between the custodian and the SMSF trustee will depend on the individual circumstances including the terms of the legal documents underpinning the relationship. In SPR 2014/1 – SMSF (LRBA – In house Asset Exclusion) Determination 2014 (Determination) the ATO extends the in-house asset exception for LRBA to before the loan is applied and after the loan is repaid but the asset continues to be held by what the ATO refers in the Determination as a “related trust” of the SMSF. Similarly, the ATO’s recent Interpretative Decisions on LRBAs and related party loans confirms the ATO’s approach that the LRBA is a separate “related trust”, to which the non-arm’s length income provisions may apply.
The ED proposes to mirror industry practices for superannuation LRBAs to ignore the LRBA trust arrangement and instead treat the SMSF trustee as the owner of the asset. The Explanatory Memorandum (EM) to the ED states the “long-standing industry practice…has been to ignore the trust and treat the investor as the owner of the asset.”
The measures contained in the ED as being clearly positive as they remove the uncertainty relating to the taxation treatment of LRBAs. If enacted, the amendments will provide a deemed look-through tax treatment for an asset held by a trust arrangement under a LRBA. Specifically, the ED clarifies that:
- The SMSF trustee is the owner of the asset from the date the SMSF trustee acquired the asset under the LRBA and no capital gains tax (CGT) event E5 will arise on payment of final instalment.
- The deemed look-through tax treatment will apply to a LRBA trust covered under the exception in section 67A(1)of the SIS Act and where the asset “vests in the trustee of the trust for the benefit of trustee of a regulated superannuation fund”: section 235-840(a) of the ED.
We note that:
- The term “vests” in section 235-840(a) of the ED does not mirror the term in the SIS Act. Ideally the terms used in the final amending legislation should be consistent with the current legislation.
- The ED does not expressly state that the look-through tax treatment will continue where the LRBA trust continues to hold an asset after the loan is repaid. We believe this needs to be expressly stated in the ED.
- The holding trust is ignored for income tax purposes. This means all income (dividends, franking credits, rental income and proceeds from sale of assets) and expenses are that of the superannuation trustee and not the trustee of the LRBA trusts (ie the custodian)
- Interest on the LRBA loan is deductible to the superannuation trustee if the general rules of tax deductibility are satisfied.
What is the impact of the ED for SMSF LRBAs?
Income Tax and CGT
If enacted the draft will apply retrospectively from July 2007 to provide deemed look-through tax treatment to all assets held by LRBA trusts satisfying section 67A (and former section 67(4A)) of the SIS Act. If the proposed amendments are enacted, the LRBA trust is ignored for income tax purposes and the ATO’s current application of the non-arm’s length provisions to related party loans under superannuation LRBAs will also need to be reconsidered.
The ED proposals amend the income tax treatment only. The Government have the opportunity to align the GST legislation with the current industry GST treatment of LRBAs under GST Ruling 2008/3 Dealings in real property by bare trustee.
The State and Territory stamp duty position for LRBAs remain unchanged under the ED proposals. Eligibility for duty concessions in each State and Territory on the stamping of LRBA trust deeds and transfer of assets from custodians to superannuation trustees will still need to be satisfied. It may or may not be necessary for a LRBA trustee to transfer an asset to the superannuation trustee for SIS Act purposes. However, to gain the duty exemption in some jurisdictions it will still be necessary to ensure that there is clear evidence (eg bank statements) to show that funding for the purchase of the asset was sourced from or for the superannuation fund.
Draft legislation submissions
The closing date for submissions is Friday 13 February 2015.
ATO Administrative treatment
The ATO will accept tax returns as lodged in the period up until the enactment of the proposed changes.
No compliance action will be taken by the ATO prior to the enactment of the proposed changes.