The use of limited recourse borrowing arrangements (LRBA) for the development of property within an SMSF should be avoided as the action may open the fund up to non-arm’s-length dealings, according to an SMSF legal expert.
DBA Lawyers special counsel Bryce Figot said the recent ATO SMSF Regulator’s Bulletin 2020/1 highlighted that while property development could be a legitimate investment for SMSFs, where the development complied with the Superannuation Industry (Supervision) (SIS) Act and Regulations, there were a number of areas of regulatory concern.
Figot said the use of an LRBA for property development within an SMSF was highlighted by the ATO in the bulletin, which noted a property development “will generally change the character of the property” and SMSF trustees could not rely on mirroring the ‘safe harbour’ terms in Practical Compliance Guideline 2016/5 to show that their terms are consistent with an arm’s-length dealing.
“These two points have the same practical implication, which is an LRBA and property development don’t mix, and I cannot overemphasise that enough,” he said as part of a webinar today.
He said the position was reinforced by a later comment in the bulletin that noted “where parties are related, there is an inference that they will not deal with each other at arm’s length”.
“The ATO stated in the bulletin it has no problems with property development if it satisfies the SIS Act and Regulations, including non-arm’s-length dealings, but the starting point of this statement is that you are a ratbag and have to prove that is not the case,” he said.
“The bulletin stated this inference can be reversed if the parties can show that despite being related, they have conducted the transaction as if they were at arm’s length, but how do you do that?
“It is easy to show what the market value is for listed securities and do the same for real estate, but when it comes to dealings for property development, this can be hard.
“If someone says they want their SMSF to be involved in real estate development and borrowings, it has to be a no-go, unless it is via an unrelated entity.
“Theoretically, a fund could issue units in a unit trust, but practically there is no way to prove the arrangements are not arm’s length and you will always have this sword of Damocles hanging over your head.
“These paragraphs in the bulletin basically say that LRBAs and property development don’t mix for the majority of times when a client says they can make a lot of money doing this, but they need to borrow to do so.”