ATO, Tax

Deductibility of LRBA costs limited

SMSF LRBA deductions

Limits apply to the tax deductibility of expenses related to setting up an LRBA with the ATO viewing legal advice as outside the deduction provisions.

An SMSF looking to establish a limited recourse borrowing arrangement (LRBA) should be aware not all aspects of that process will be eligible for tax deductions and the fund will have to bear the cost of legal expenses to set up the arrangements.

Smarter SMSF chief executive Aaron Dunn said SMSFs could claim a tax deduction for legal expenses not covered by specific provisions in the Income Tax Assessment Act, except where those expenses were incurred in deriving non-assessable income or were capital, private or domestic in nature.

Dunn said this had implications for an SMSF with an LRBA as a distinction was made between deductions related to the borrowing and deductions related to the structure through which the borrowing takes place.

“Take the case [of] a fund that engages a legal firm as they are going to enter into an LRBA to acquire an asset and we know to comply with Section 67A of Superannuation Industry (Supervision) (SIS) Act we need to hold that asset on trust through a bare trust or holding trust arrangement to comply,” he said during a webinar today.

“Now, section 25.25 of the Income Tax Assessment Act is a specific deduction provision and this enables the taxpayer to deduct expenses incurred for borrowing money to the extent that the money is being used for producing assessable income for the taxpayer – in this instance, the fund.”

He said these expenses could include loan establishment fees, valuations for an asset, costs of documenting guarantees required by the lender, mortgage insurance in respect of that lender and any fees for property title searches and filing mortgage documents.

These expenses did not include costs for establishing the LRBA, including the creation of the holding trusts and the underlying agreement, he said.

“These are not considered to be borrowing expenses because what we’re actually doing is incurring a cost to establish an arrangement through which the borrowing occurs, rather than through the borrowing itself,” he said.

“On that basis, the SMSF is unable to claim a deduction for the legal costs incurred in establishing that arrangement because it is a legal expense that could not be claimed in setting up the trust under section 25.25 and because the cost is general capital in nature.”

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