It is now possible for self-managed super fund (SMSF) trustees to borrow, subject to certain conditions. One condition is that the asset acquired must be held on trust for the SMSF trustee. This trust is often referred to as an instalment warrant trust, a bare trust, a debt instalment trust, et cetera.
It is possible to comply with this “instalment warrant trust” condition in a very tax-efficient way. However, there are a number of common mistakes that can give rise to unnecessary tax risks.
By being aware of the most common mistakes in setting up and maintaining SMSF borrowings – and how to avoid them – a good financial planner can add significant wealth to clients.
This article assumes the SMSF trustee is acquiring real estate.
START AT THE END
The initial purchase of the property gives rise to a stamp duty liability. Upon repayment of the loan, the instalment warrant trustee might transfer the property to the SMSF trustee.
Whether this transfer at the end of the arrangement (that is, from the instalment warrant trustee to the SMSF trustee) is subject to duty depends heavily on how the arrangement was entered into at the start.
Accordingly, it is vital to be aware of any relevant stamp duty exceptions that might apply when the property is transferred from the instalment warrant trustee to the SMSF trustee. Each jurisdiction is different.
One relevant exception in Victoria, New South Wales, Tasmania and WA in respect of the transfer at the end of the arrangement is the “apparent purchaser” exception. Broadly, the apparent purchaser exception provides that property may be transferred from an apparent purchaser (for example, the instalment warrant trustee) to a real purchaser (for example, the SMSF trustee) without significant stamp duty if the real purchaser provided the money for the purchase.
Therefore it is vital that it can be demonstrated that:
purchaser (that is, the SMSF trustee). This includes the deposit. This is best evidenced
by bank statements.
The most common mistakes are:
A different entity pays some of the purchase price. This usually happens where clients pay the deposit personally.
The client completes the purchase con- tract in a manner that does not give due regard to the stamp duty exceptions at the end.
The instalment warrant trustee and/or the SMSF trustee is not incorporated at the time of the signing of the purchase contract.
None of these mistakes are fatal. Depending on the jurisdiction, there can be different solutions. However, if the client has made any of these mistakes, financial planners should caution them that proceeding with an SMSF borrowing might have some risk of additional stamp duty.
IT MUST BE A TRUST
The legislation does not specify what type of trust the instalment warrant trust must be. It only specifies that it must be a trust. The most popular type of trust is a bare trust. A bare trust is broadly a trust where the trustee holds property without any duties except to transfer the property upon demand by the beneficiary.
Bare trusts are popular for a number of reasons. One reason is GST. The Commissioner now accepts that the beneficiary of a bare trust (for example, the SMSF trustee) may carry on an enterprise involving the use or exploitation of real property even though title to the property is registered in the name of a bare trustee (for example, the instalment warrant trustee).
This is important where the property is commercial and the GST turnover is greater than $75,000. This means that rather than having to register the instalment warrant trust for GST, only the SMSF needs to be registered.
This also means if the property is transferred to the SMSF trustee, this does not constitute a taxable supply and thus does not give rise to a GST liability.
However, in order to receive this special concessional treatment the trust must truly be a bare trust. In other words, the activities of the bare trustee (that is, the instalment warrant trustee) should be essentially passive in nature and the bare trustee should have either no active duties to perform or only minor active duties.
Accordingly, wherever legally possible, it should be the SMSF trustee who signs documentation on behalf of the property. Sometimes the instalment warrant trustee will have to sign documentation in order for the documentation to be effective. Where this is the case, it should be recorded that the trustee is acting on the instructions of the beneficiary (that is, the SMSF trustee).
Another reason is income tax efficiency. The trustee of a “transparent trust”, such as a bare trust, is not required to furnish an income tax return. Therefore — if a bare trust is used — only the SMSF needs to furnish an income tax return.
Also, where a bare trust is used, there is a strong argument to say that the SMSF trustee is absolutely en-titled to the property and that where the property is transferred from the instalment warrant trustee to the SMSF trustee, there are no capital gains tax (CGT) implications.
A common mistake is for the instalment warrant trustee to have its own Australian Business Number (ABN), Tax File Number (TFN) or bank account. These things suggest that the instalment warrant trustee has active duties. The instalment warrant trustee should have none of these things. The SMSF’s ABN, TFN and bank account should be used. This helps demonstrate that the instalment warrant trust truly is a bare trust and is eligible for all favourable tax treatment described above.
A switched-on financial planner can add great value in ensuring that tax efficiency is achieved. As detailed above, subject to the jurisdiction, tax efficiency is achieved by ensuring the client:
– signs the purchase contract correctly;
– pays the deposits correctly;
– does not obtain a TFN, ABN or bank account for the instalment warrant trust.