SMSF advisers and trustees need to be mindful of the complexity involved with using back-to-back loans to fund limited recourse borrowing arrangements (LRBA), a sector specialist has said.
Back-to-back loans arise from situations where monies are borrowed from a regular banking institution by a member or related party, without the involvement of the super fund, and then in turn lent to the SMSF as a related-party LRBA.
According to SMSF Alliance principal David Busoli, this type of arrangement has three major identifiable flaws, one of which is the potential mismatch in the loan terms.
“The bank loan conditions will not be the same as the related-party loan conditions, however, the members often regard them as such. The related-party loan will usually emulate the safe harbour provisions, which for property is a 15-year principal and interest loan at currently 5.1 per cent. The bank loan may easily be for a longer term, interest only and at a lower interest rate,” Busoli noted.
“Trustees often believe that they merely need to match the bank’s requirements with what the SMSF pays them. I have even encountered situations where the member has reduced the bank loan, via their own resources, and regarded this as a reduction of the SMSF debt as well.”
These circumstances make it imperative for all of the parties involved to understand the two transactions are completely separate to one another and the terms of each loan agreement need to be well understood, he advised.
To this end, a written explanation is only a minimum standard, he said.
He warned there is also a danger trustees can be caught out by the compulsory inclusion of the LRBA liability in a fund member’s total super balance for loans taken out after 1 July 2018.
“The effect can be dramatic. The member may have a debt repayment strategy that includes the making of non-concessional contributions, however, they may be precluded from making those contributions because of the existence of the debt. A nasty circular argument indeed,” he said.
Further, he pointed out these gearing arrangements carry tax consequences making it necessary for the related parties to include both sets of loan transactions in their income tax returns.
He reminded advisers of their ability to simplify the gearing process by making trustees aware there are institutions outside of the conventional banks offering LRBAs.
“In summary, back-to-back SMSF loans need to be well understood by all parties. They may represent an alternative, when offered by a bank that has no alternative, but they may not represent the best alternative,” he said.