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Limited recourse borrowing arrangements (instalment warrants) Repaid loans and in-house assets

In another article this month in which we considered the risk of "double stamp duty" being payable on an SMSF's "limited recourse borrowing arrangements" we suggested that the second stamp duty payment could be avoided by not transferring property held in a custody trust after the relevant loan is repaid.

The ATO has given its view that this approach could infringe the in-house asset rules in section 71(1) of the Superannuation Industry (Supervision) Act 1993 (SIS Act). We don't agree with this view. The ATO is reviewing its decision.

Paul Ellis

The in-house asset rules

An SMSF must not invest in in-house assets so that the total value of interest in in-house assets exceeds 5% of the total value of the superfund's assets[1].

An in-house asset as "an asset of a fund that is a loan to, or an investment in, a related party of the fund, an investment in a related trust of a fund, or an asset of the fund subject to a lease or a lease arrangement between a trustee of a fund and a related party of the fund"[2] . This definition is subject to a large number of exemptions.

How do the in-house asset rules apply to limited recourse borrowing arrangements?

The SIS Act contains a number of requirements that SMSF trustee(s) must meet if they wish to purchase an asset (an acquirable asset) using borrowed funds[3]. These include:

  • the acquirable asset purchased must be held on trust so that the trustee acquires a beneficial interest in the acquirable asset (section 67A(1)(b)); and
  • the superfund trustee must have a right to acquire legal ownership of the acquirable asset by making one or more payments after acquiring the beneficial interest (section 67A(1)(c)).

The trust that the superfund trustee must establish to meet these requirements (Custody Trust) will be an investment in a related trust of the superfund. However, the Custody Trust will be exempt from the in-house asset rules under an exemption in section 71(8) of the SIS Act. This section provides:

(8) If, at a time:

  1. an asset (the investment asset) of a superannuation fund is an investment in a related trust of the fund; and
  2. the related trust is one described in paragraph 67A(1)(b) in connection with a borrowing, by the trustee of the fund, that is covered by subsection 67A(1); and
  3. the only property of the related trust is the acquirable asset mentioned in that paragraph;

the investment asset is an in-house asset of the fund at the time only if the acquirable asset mentioned in that paragraph would be an in-house asset of the fund if it were an asset of the fund at the time.

Does this exemption continue apply after the loan is repaid?

In the ATO's view, the exemption in section 71(8) ceases to apply once a limited recourse loan is repaid — see "Limited recourse borrowing arrangements by self-managed super funds — questions and answers" (a copy of which can be downloaded by clicking here (ATO Q&A).

Under this view, an SMSF's interest in a Custody Trust will become an in-house asset on repayment of a limited recourse borrowing arrangement under section 67A(1).

Why Maddocks doesn't necessarily agree with the ATO's view

Maddocks considers that ATO's view is not necessarily correct. This is because Section 71(8) of the SIS Act does not specify that a loan obtained by an SMSF's trustee(s) under section 67A must be unpaid for the SMSF trustee's interest in Custody Trust to qualify for the exemption from being an in-house asset. The Custody Trust merely needs to be one that is "in connection with a borrowing ... that is covered by subsection 67A(1)". In our view, a Custody Trust will be "in connection with a borrowing" under section 67A(1) even if the loan has been repaid.

There is nothing in section 67A that requires the SMSF trustee(s) to take legal title to an acquirable asset held in trust after a loan is repaid. Section 67A(1)(c) requires only that the SMSF trustee(s) have a right to acquire legal ownership by making one or more repayments.

Moreover, it could be in the interests of the SMSF trustee(s) to continue to hold property in a Custody Trust. For example, as we discussed in our related article, in some States, stamp duty may be payable on the transfer of dutiable property from a Custody Trust to an SMSF trustee.

Will the ATO reconsider its view?

Concerns with the format of the ATO's question and answer on this issue in the ATO Q&A were raised with the ATO in the National Tax Liaison Group (NTLG) Superannuation Sub-committee meeting on 15 June 2010. Specifically, one of the members stated that he did not consider that a Custody Trust (the member used the term 'bare trust') would be an in-house asset after a loan was extinguished. The member did not feel that the in-house asset rules were designed to prevent SMSF trustee(s) from holding assets through nominees.

The ATO did not provide an immediate response to this concern. Instead, the ATO invited submissions from the non-ATO members of the NTLG Superannuation Sub-committee by 23 June 2010. The minutes from that meeting state that submissions were provided, but these have not been published. We expect this issue to be included in future meetings of the NTLG Superannuation Sub-committee.

We will continue to monitor the issue and will provide ClearLaw readers with an update when more information is at hand.

In the meantime, can we disregard the ATO's view?

It may not be an issue for quite a while

For most limited recourse borrowings arrangements, the ATO's view will not be an issue for many years because:

  • most limited recourse loan agreements will have a term of 10 or 20 years or longer; and
  • limited recourse loans have only been available since September 2008, so no arrangement will be more than 2 years old.

However, some SMSF trustee(s) will want to repay their loans quickly. Those trustees should take the ATO's view into consideration when planning what to do when the loan is repaid. Under section 84 of the SIS Act, failure to comply with the in-house asset rules, can attract civil and criminal consequences for trustees who fail to take reasonable steps to ensure that the in-house asset rules are not breached.

So, are there any other options?

While the ATO's view is being tested SMSF trustees have the following options to ensure that they don't infringe the in-house asset rules:

  • If the lender is a related party, leave a nominal amount owing under the loan, at call by the lender; and
  • If the lender is a bank, arrange for a member to take an assignment of the debt from the bank at the end of the loan and then leave a nominal amount owing.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask for a member of the Maddocks Superannuation Team.

More Cleardocs information on SMSFs

Order SMSF related document packages

Set up an SMSF

Update an SMSF deed

Set up an SMSF pension

Arrange SMSF borrowing lending docs:

Set up an SMSF corporate trustee

SMSF Death Benefit Nomination - binding or non binding

SMSF Death Benefit Agreement - binding and permanent


Download a checklist of the information you need to order a document package.

[1] Section 83 of the SIS Act.

[2] Section 71 of the SIS Act.

[3] Section 67A(1) of the SIS Act.


Lawyer in Profile

Paul Ellis
Paul Ellis
Special Counsel
+61 3 9258 3524

Qualifications: LLB, Deakin University, BA (Political Science), Monash University

Paul is a Special Counsel in Maddocks Government and Not-for-Profit Commercial team. He specialises in:

  • the establishment, governance, operations, regulation and administration of charities and other not-for-profit entities,
  • in commercial arrangements for the procurement or supply of goods and services, including technology services, and
  • in compliance and enforcement activities undertaken by government agencies.

Paul is Maddocks' main authority in relation to the Personal Property Securities Act 2009.

He has an in-depth understanding of the government sector, as his experience prior to Maddocks includes 13 years with the Victorian Department of Justice.

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