LRBA Update
Team Intello
Team Intello

Intermediary LRBA

The ATO has recently released SPR2020/1 which enables an intermediary LRBA (limited recourse borrowing arrangement) to be used by SMSFs without the investment triggering the in-house asset rules.  This ruling could potentially open the doors for SMSFs to access a wider pool of lenders and avoid some of the high interest rates and heavy legal costs associated with existing property limited recourse borrowing arrangements.

What is an intermediary LRBA?

Typically when an SMSF enters into an LRBA the title of the asset (for example direct residential or commercial property) is held by a holding trustee and the SMSF itself is both the principal borrower as well as the beneficial owner.

By comparison, with an intermediary LRBA, the holding trustee holds the title of the asset AND is also the borrower as principal rather than the SMSF.  The SMSF remains the beneficial owner in all cases.

Why the change and need for this ruling?

SPR 2020/1 was issued to correct an anomaly where an intermediary LRBA would make the SMSFs investment via the holding trust an in-house asset of the fund.

The ruling has some very specific provisions however that must be adhered to.

In addition, there is no impact to existing or future LRBAs where the SMSF is the principal borrower and the lender takes security over the property held by the holding trustee.

What is the benefit of an intermediary LRBA?

In theory, this ruling opens the doors for more lenders to enter the SMSF loan space and hopefully increase competition.  Some lenders will only lend where the principal borrowing (in this case the trustee of the holding trust) also holds title of the property that will be used as security.

Another key difference is that the loan does not have to be limited in it’s recourse – i.e. the loan from the bank or lender can in theory be a standard investment loan made to the holding trustee and secured by way of first mortgage over the property or asset (likely with personal guarantees from the SMSF members who would also be the directors and shareholders of the holding trustee company).

The limited recourse borrowing agreement is in place between the holding trustee and the SMSF.  This agreement limits the trustee of the SMSF (as well as the director of the trustee company who may have provided personal guarantees for the lender) are limited in their ability to claim only against underlying acquirable asset (property) to ensure the overall agreement meets the requirements of s67A of the SIS Act.

The directors / trustees of the holding trust should be the same individuals as the directors / trustees of the SMSF.

In a practical sense, this ruling will only impact a very small number of SMSFs and is more of a legislative ‘tidy up’ than a strategic opportunity.

What are the conditions under SPR2020/1

Under the new rules, the intermediary LRBA is an arrangement that meets the following requirements:

  1. a holding trust is established with members of a fund being the only trustees or the only shareholders and directors of the corporate trustee (Holding Trustee);
  2. the trustee of the fund (SMSF) is the only beneficiary of the holding trust;
  3. the Holding Trustee holds an acquirable asset (Asset) on trust for the trustee of the fund, who is beneficially entitled to the Asset;
  4. the asset is a single acquirable asset (as referred to in subsection 67A(1)) that the trustee of the fund is allowed to acquire under the SIS Act;
  5. the Holding Trustee enters into a borrowing as principal with a lender with the borrowing secured by a mortgage over the Asset;
  6. the contract or deed of borrowing between the Holding Trustee and the lender may not limit the lenders right of recourse, under the contract or deed, to only the Asset in the event of default;
  7. the lender may require that personal guarantees are given as part of the Intermediary LRBA;
  8. the arrangement is established by a legally binding deed(s) under which the trustee of the fund and the Holding Trustee agree for:
    (i)     the trustee of the fund to maintain all borrowing obligations entered into by the Holding Trustee in respect of the borrowing arrangement referred to in paragraph 5;
    (ii)    the trustee of the fund is absolutely entitled to any income derived from the Asset, less fees, costs, charges and expenses incidental to the acquisition holding or management of the Asset;
    (iii)   the trustee of the fund has the right to acquire the legal title of the Asset on completion of the borrowing referred to in paragraph 5;
    (iv)   the rights of the Holding Trustee or any Guarantors against the trustee of the fund following default on the borrowing referred to in paragraph 5 is limited to the Asset.
  9. The documentation referred to in paragraph 8 is disclosed to the lender in connection with the borrowing arrangement referred to in paragraph 5.

Intermediary LRBAs require the holding trust documentation to be more prescriptive. In order to ensure that the arrangement can rely on the ATO’s determination as an exception to the in-house asset rule, the holding trust deed must have been carefully drafted and executed as a legally binding deed encompassing all the prescribed conditions in the determination.

Intermediary LRBA versus Standard LRBA Diagram

Intermediary LRBA FAQs

Who pays the holding trust loan repayments?

The SMSF as the beneficial owner of the underlying asset is still expected to make the loan repayments.  In a practical sense we believe this would simply involve nominating a bank account of the SMSF as the account from which the lender would deduct loan repayments.

Does the holding trust need to prepare accounts and lodge income tax returns?

No. As per SECT 238.820 of the ITAA97, the holding trust is considered a look-through entity.  This means the holding trust is not a reporting entity and doesn’t need to prepare financial statements or income tax returns.

Does the holding trust need to be registered for GST?

No. A look-through approach also applies to GST in the case of a holding trust.

Sect 235-820(5) of the ITAA 1997 also provides:

Any consequence arising under the GST Act for the trustee of the instalment trust, as a result of anything done in relation to the instalment trust asset, is treated as if it had arisen for the investor (instead of for the trustee), even if that consequence would not have arisen had the thing been done by or to the investor.

The SMSF is treated as the ultimate entity when making supplies and claiming input tax credits for GST purposes.

Does the holding trust need it’s own bank account?

Possibly. This may depend on the lender providing the mortgage to the holding trust. If the lender requires a transaction account for loan repayments to be available in the name of the holding trust as borrower, then yes, the holding trust will have a separate bank account purely for the loan repayments and loan fees levied.

As the SMSF is required to ‘maintain all borrowing obligations entered into by the Holding Trustee in respect of the borrowing arrangement’ under SPR2020/1 then the actual monies used for interest and principal repayments would come from the SMSF.  This would cover both where the monies were paid direct from the SMSF bank account and also where the monies from the SMSF were transferred to the holding trust bank account and then to the lender.

From an accounting and reporting perspective the holding trust bank account would be held with the SMSF as the beneficial owner and any interest paid and fees charged would be recorded in the accounts and annual return of the SMSF using the above-mentioned look-through provisions.

Can an existing ‘direct’ LRBA be re-financed to an intermediary arrangement?

In theory, yes.  In addition to a new loan being secured by the holding trust in its own right, the following would also need to occur:

  • The existing bare trust (holding trust) deed would need to be amended to accommodate the provisions of SPR2020/1
  • A new limited recourse borrowing (LRBA) deed be drafted between the trustee of the SMSF and the trustee of the holding trust to fulfill the provisions of SPR2020/1
  • The new LRBA deed between the SMSF trustee and holding trust trustee would need to be disclosed to the lender
  • Personal guarantees from the members / directors to be executed as part of the loan

Do the directors / trustees of the holding trust need to be the same as directors / trustees of the SMSF?

Yes. While the wording of the ATO determination may be somewhat ambiguous as to whether it necessarily requires each and every member of the fund to be a director and shareholder of the holding trustee company, best practice would be to ensure compliance by having all SMSF members as directors and shareholders of the holding trustee company.

Comments and Questions

Whether this ruling on intermediary LRBAs is purely a small tweak to ensure existing arrangements don’t unintentionally trigger the in-house asset rules, or whether it enables greater flexibility around SMSF lender is yet to be seen.  On the surface it may enable SMSFs to access a greater pool of lenders and thereby possibly borrow at more attractive investor rates compared to existing higher rate and costly SMSF loan products that are in the market.

We are genuinely interested in your comments and will also be updating this article as more information becomes available. In the mean time, please get in touch if you have any questions or comments.

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