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Business succession planning - don't wait too long

- by Brett Davies, Civic Legal, Perth

Much has been, and continues to be, written about business succession planning. But, is anyone really listening?

Most people think about making a Will during their life. However, too many business people do not consider a business succession plan (BSP) for after they're gone. A BSP is essential, especially where a business has more than one partner involved.

In 2000, the ATO told us how it thought BSPs should be structured - this was through release of its Business Succession Arrangements Discussion Paper (Buy-Sell Agreements). At that time, Self-owned or the Superannuation Fund owning the insurance looked OK.

However, at the National Tax Liaison Group (NTLG) meeting in December 2010 (Agenda Item 9), the ATO said the 2000 BSP discussion paper had been withdrawn. The ATO also said that anyone relying on that discussion paper should cease to do so as it could "not be regarded as current".

That means any existing BSPs need reviewing.

What needs to be considered?

Business owners need to discuss their plans with their accountants and advisers. Important things to consider are:

Who is involved in the business other than family?
How is the business structured (eg company, trust, partnership or a combination of one or more of these)?
Do you get along with your business partner's spouse?
Does your business partner's spouse know anything about your business?
Who would you like to take over your legacy once you are gone?
How does the surviving business partner find the money to buy out the interest of the deceased partner?
Do you want to continue in the business once your partner dies?
Do you want to have the option to buy out the share of the deceased business partner?
Do you want the deceased estate to be able to force you to buy out their share?

How to fund the buy-out of the deceased partner's share?

Most people do not hide large quantities of cash under the mattress any more. It is not tax effective to do so! Most people in business prefer to have "good debt" in place to reduce their taxable income.

So, given lots of business owners are geared up to fund investments - how do they find the money to buy-out their partner's share at such short notice?

The most common approach is to purchase insurance. Sounds like an easy solution. But there are issues to consider about how to hold the insurance and who gets the benefit from it.

A number of funding mechanisms are available. The most successful funding method is a combination of life policy, trauma policy and total and permanent disability policy. Of course, insurance policy ownership has its own minefield of tax consequences, just some of which include:

A CGT exemption applies for the disposal of rights under a life assurance policy, or a disposal of an interest in those rights. The CGT exemption is subject to the qualification that it does not apply if the person making the disposal is not the original beneficial owner and acquired the rights or interest for an amount of money or other consideration.
The tests are cumulative. That is, a disposal by a person who is not the original beneficial owner still qualifies for exemption under s 118-300 if the person provided no consideration in acquiring those rights.
The term "original beneficial owner" is not defined and has no accepted legal meaning. In Taxation Determination TD 94/31, the Commissioner states that the original beneficial owner is the first person who: (i) at the time the policy is effected, holds the rights or interest; and (ii) possesses all the normal incidents of beneficial ownership, eg is entitled to the benefits of the policy proceeds and has the power of management and control over the policy, as well as the power to transfer, grant as security, surrender or otherwise dispose of the policy.
Premiums payable under "trauma" insurance policies are generally not allowable deductions for Business Succession Planning. The purpose of trauma insurance is to provide a capital amount to the insured in the event of a specified medical condition occurring. If the policy does not replace earnings lost by the taxpayer, then the Commissioner considers that the benefits payable under trauma policies do not constitute assessable income.
Section 118-15(a) and (b) exempt any sum received by way of compensation or damages for any wrong or "injury" suffered by the taxpayer "to his or her person", or "in his or her profession or vocation". "Injury" is not limited to physical injury. The Commissioner accepts that a specified illness in a trauma insurance policy is an "injury" for the purposes of section 118-15(a) and (b): Taxation Determination TD 95/43.

What about using an Insurance Trust Deed to hold the life insurance policy?

On 1 September 2010, the ATO released Product Ruling PR 2010/18 (reported at 2010 WTB 38 [1481]), concerning a particular BSP arrangement. The Ruling applies to a beneficiary under the Insurance Trust Deed who is absolutely entitled to the rights under an insurance policy held on trust for the beneficiary. That ruling only applies to non-death benefit insurance pay-outs.

However, the meetings of the NTLG reveal that the ATO is yet to provide guidance on who is absolutely entitled under a Trust. The ATO did however, at the December 2010 NTLG meeting, refer to its Decision Impact Statement on the Federal Court decision in Kafataris v DCT (2008) 73 ATR 531. Essentially, where there is any discretion bestowed on the Trustee of the Insurance Trust, the CGT exemption described in the PR 2010/18 is lost.

The issue that arises is the basis on which the ATO says that the transfer must be automatic. Strangely, the Draft Ruling offers no references to where in the SIS Act or SIS Regulations that the trustee of the fund is required to transfer the entitlement to a pension automatically to the reversionary or dependent beneficiary.

There are many issues to consider in relation to BSP, and great care and planning is needed.

[Brett Davies is co-author, with his colleague Tim Pepper, of the Estate Planning chapter of the Thomson Reuters Australian Financial Planning Handbook. The Handbook also contains excellent material on BSP.]

(extracted from Thomson Reuters Weekly Tax Bulletin 37 - 02/09/11)

Superannuation: Draft TR 2011/D3 - A new world order or just the status quo?

- by Brett Davies, Principal, and Tim Poli, Civic Legal, Perth

For those of us who may have been living under a rock for the past week, in Draft Taxation Ruling TR 2011/D3 (reported at 2011 WTB 30 [1182]), the ATO has fundamentally changed the way superannuation is treated upon the death of a fund member.

Or has it?

If you are not like me and don't find enjoyment from trawling through mountains of tax rulings, then you can skip ahead to para 63 onwards of Draft TR 2011/D3 to where things get a bit juicy.

The intention of the Draft Ruling is to provide clarity to tax and superannuation practitioners (and hence their clients) of how the ATO intends to treat the benefits of members of superannuation funds that die whilst their account is in pension phase. Despite the media outpouring, perhaps the real question being asked by the media coverage of the Draft is whether anything has really changed? Or whether perhaps some practitioners may have misinterpreted the law from the outset?

The Draft Ruling discusses 3 key issues for superannuation funds:

When a superannuation income stream, or pension, commences.
When a superannuation income stream, or pension, ceases.
What happens to any residual benefit of a superannuation income stream, or pension, when a member dies.

When does a superannuation income stream, or pension, commence?

A superannuation income stream or pension commences on the first day of the period to which the first payment of the pension relates (SIS Regulations 1994, reg 1.3). The ATO suggests that the commencement day is also subject to the rules of the superannuation fund as to when pensions may be payable to members. Further, the commencement day cannot be prior to the date on which the member applies to the Trustee of the fund to commence the pension.

The importance of the commencement day of the pension is that all contributions and rollovers to the relevant member's pension account must be made prior to the commencement day to determine the tax-free and taxable amounts of the interest (s 307-125 of the ITAA 1997 and SIS Regulations, reg 1.06(1)(a)(ii)).

Once the pension commences, the portion of the member's interest that supports the pension is treated as a separate interest and is exempted from income tax (s 295-385 of the ITAA 1997).

When does a superannuation income stream, or pension, cease?

The Draft Ruling identifies that a superannuation income stream or pension ceases on the date that there is no longer a member of the superannuation fund, or a dependant beneficiary of a member, that is entitled to receive the pension. The position in the SIS Regulations is that the pension must meet the requirements of subregs 1.06(2), (9A) or (9B), re pension rules and minimum payment standards, and if the pension no longer meets any of those criteria at any point in time, the pension ceases on that date.

Further ways that the pension may cease are by the exhaustion of the capital that supports the pension, and by the member commuting the pension to receive a lump sum benefit. The commutation of a pension by the member causes the pension to cease because it no longer meets the criteria of subreg 1.06(2), in that there is no longer a regular payment that is paid at least annually.

What happens to the residue of a member's pension account upon death?

The Draft Ruling provides that the rules of the superannuation fund "must ensure that the pension is transferrable to another person (the reversionary beneficiary) only upon the death of a member". It goes on to say that where the rules of the superannuation fund do not comply with those requirements, the pension ceases as at the date of death of the member.

The real controversy surrounding the Draft Ruling centres upon whether the "entitlement to a superannuation income stream" is required to be automatically transferred to a dependent beneficiary (or reversionary beneficiary) on the death of a member. The ATO, in the Draft, says that unless the pension automatically transfers to the dependent beneficiary, the pension of the deceased member ceases at that time. If the trustee of the superannuation fund exercises some discretion bestowed upon them by the rules of the fund to pay a pension to the dependent beneficiary, that pension is a new pension and not a continuation of the deceased member's pension.

Neither the SIS Act nor the SIS Regulations specifically deal with the issue of whether an entitlement to a pension must be transferred automatically upon the death of the member. Subregulations 1.06(2)(g) and (9A)(c) provide that the pension entitlement is only transferrable upon the death of the beneficiary. Further, subreg 6.21 requires the trustee to cash in or pay the deceased member's benefits as soon as practicable after the member dies.

Arguably, there is nothing in the legislation that prevents the trustee of the fund exercising some discretion as to whether the deceased member's pension entitlement is paid to the reversionary or dependent beneficiary as a pension or as a lump sum or paid to the estate of the deceased member. Providing the trustee of the fund acts within a reasonable time to exercise that discretion, and the power exists in the superannuation fund deed for the trustee to exercise that discretion, it appears that such an action is compliant with the SIS Regulations.

The key issue is whether the reversionary pension beneficiary is properly identified in the Deed or the documents upon which the pension was created. Providing the reversionary pension beneficiary is identifiable, any transfer to that person by the trustee of the deceased member's pension entitlement would be in accordance with the SIS Regulations.

Conclusion

It would appear that what the ATO may have overlooked in its drafting of the Ruling is that subregs 1.06(2), (9A) or (9B) collectively provide that a pension exists at all times where the member or reversionary beneficiary are alive, the pension has not been wholly commuted and the capital supporting the pension has not been exhausted. Upon accepting that the above-mentioned criteria are essential for the existence of a pension, it logically follows that providing a reversionary beneficiary, whom meets the criteria of subreg 6.21, is nominated by the member, the pension must continue to exist until that reversionary beneficiary commutes the pension, exhausts the capital supporting the pension or dies.

Where the media coverage of the Draft Ruling appears to have deviated from the correct application of the SIS Act and the SIS Regulations is to consider that the tax concessions applicable to a deceased member's pension account continue after they have died even where no reversionary beneficiary is nominated. There is no basis for that interpretation of the SIS Act and the SIS Regulations. The criteria for the existence of a pension in the SIS Regulations are clear and unequivocal. It logically follows that where those criteria are not met, the pension cannot exist at law and therefore the concessional treatment of the pension account must also cease from that point onwards.

Despite the efforts of the ATO to provide clarity to this complicated and voluminous area of practice, the Draft Ruling has unfortunately failed to do so thus far. What the release of the Draft has achieved however, is to identify the misconceptions as to the concessional taxation treatment of pensions after the death of a super fund member. At the very least, the Draft Ruling has sparked much debate and has the potential to provide better clarity to the industry when it is published in final form.

Some concern has also been raised about the retrospective application of the Ruling (when it is finalised) from 1 July 2007. However, perhaps this is a little unfair as the ATO is essentially saying that the Draft is simply stating its views on how the relevant laws have applied since the Simplified Superannuation reforms commenced operation on 1 July 2007.

Suggested strategies

In our opinion, there are 2 strategies available to ensure the members of the super fund and their beneficiaries can take full advantage of the concessional taxation treatment that is available to superannuation pension accounts. Those strategies are:

1. Always ensure there is a "dependant" (as defined in the SIS legislation, not the Income Tax Assessment Act) living at the time of the member's death. These "dependants" need to be carefully documented and evidence retained to prove the "dependant relationship" where an obvious "dependant", such as a spouse or minor child, does not exist. You also need to ensure that a dependant is always nominated as your reversionary pension beneficiary. Without such a nomination being made, the pension ceases upon the death of the member.

2. Keep liquidating the capital assets in your pension account that support the payment of your pension. It is only the assets in the pension account that receive the concessional tax treatment on offer in s 295-385 of the ITAA 1997. If you realise all of the capital gains during your lifetime and while your account is in pension phase, your beneficiaries receive only cash and no capital assets. The benefit of this strategy is that no CGT is paid by your non-dependant beneficiaries after you die.

(extracted from Thomson Reuters Weekly Tax Bulletin 32 - 29/07/11)

Family Trusts and "streaming": life after Bamford

- by Brett Davies, Civic Legal, Perth

The streaming of dividends and franking credits by discretionary trusts is a lively issue - and not only as a result of the High Court's decision in FCT v Bamford (2010) 75 ATR 1. Another more recent decision has also stirred some interest.

That decision was one by the Supreme Court of Qld late last year, where the Court held that a trustee of a discretionary trust was empowered to allocate franking credits differentially from net income. That is, the franking credits were distributed to an individual beneficiary out of proportion to the dividends to which the franking credits were attached. This decision of Applegarth J in Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417 (reported at 2010 WTB 49 [1884]) is interesting.

Facts of the Thomas Nominees case

The Thomas Investment Trust is a discretionary family trust (Family Trust). At the end of the relevant financial year, the trustee of the Family Trust prepared trust minutes to distribute the franking credits and the rest of the net income. No income was left in the trust undistributed. The distribution was effected through 2 separate distribution resolutions (instead of doing this in one distribution minute). The first resolution concerned the distribution of net income to an individual ($5,000) and a company ($138,000), which did not include the franking credits. The second resolution concerned the distribution of the franking credits to the individual.

The accountant stated that the distribution ensured that all the taxable income of the trust (described also as "the section 95 net income"), and all the franking credits, were "distributed and allocated among the beneficiaries so that:

that income became the beneficiaries' assessable income under s 97;
the beneficiaries could utilise the franking credits distributed to them;
there was no amount for which the trustee was liable to tax under s 99A;
there were no wasted franking credits being wasted by being left with the trustee".

It was the trustee's intention to make the separate and specific resolution relating to the distribution of the franking credits. This was to ensure the trust "distributed income and franking credits in a way that would not attract more income tax than was necessary". The trustee submitted that a differential allocation of the franking credits was permitted because of an example given in s 207-35 of the ITAA 1997, and also at general law.

The ATO challenged the allocation of the franking credits.

What was the Court's view?

The Court held the trustee's intention was clear: the franking credits were intended to be allocated according to resolutions to distribute net income, not the other resolution to distribute franking credits. The Court made it clear that the ATO's suggestion did not accord with:

the trustee's clear intention in making the resolutions;
the client's instructions to the accountant in preparing the resolutions;
the terms of the resolutions which, when read together, clearly indicated that a separate, specific resolution related to the distribution of franking credits.

The trustee felt that it was necessary to confirm its position and seek the Court's direction as to the proper construction of the resolutions.

As explained by Applegarth J in paras 50 and 51 of the Thomas Nominees case:

"[50] The resolutions under consideration purported to allocate the franking credits differentially. I am unable to see why the trustee was not empowered to do so. I accept the applicant's argument that the Parliament, by providing as it has for the inclusion of franking credits as assessable income and for the allocation of the assessable income of which they form part, has given franking credits many of the same attributes as other categories of income. Franking credits are a benefit that the Deed authorised the trustee to distribute as part of the income of the Trust. The Deed authorised the trustee to distribute them differentially between beneficiaries."

"[51] I conclude that the resolutions were effective to distribute the franking credits according to the intent of the trustee, as reflected in the dual resolutions. The franking credits were allocated in accordance with the resolutions that specifically addressed them, and not, as the ATO apparently suggests, by the other resolution that dealt with other categories of net income."

Overall, the Qld Supreme Court accepted the trustee's submission that a differential allocation of the franking credits was permitted because of s 207-35 of the ITAA 1997.

The Court confirmed that the franking credits were net income under s 95 of the ITAA 1936. Nevertheless, the Trustee was entitled to distribute the franking credits in a different proportion to the remaining net income. The power to do so was contained in the trust deed. This highlights the importance of reading the Deed. It can also be important to use a lawyer that specialises in this area. Many accountants don't follow this advice, to their peril.

ATO's position on streaming

I am expecting the ATO to announce a major revision of its views on the streaming issue, in which case deeds will need to be rewritten. One hopes this won't happen, as it has been an established area of law since the early 1990s. However, following the High Court's decision in Bamford, the ATO has challenged the basic tenant that trusts can stream different categories of income to different beneficiaries. Such an approach would reduce the Thomas Nominees case to its specific case facts only and, sadly for everyone else, the case would have no practical use. Further, the Thomas Nominees case related to 2005 tax returns - however Bamford was decided in 2010. The ATO may argue that the Thomas Nominees case relates to old law. I hope not.

Trust deeds

Family Trust Deeds can be constructed so that the Trustee in a Family Discretionary Trust is given absolute power to distribute all forms of income of whatever nature (including franking credits) to the Beneficiaries in whatever proportion the Trustee sees fit. Family Trust Deeds can also allow you to separately deal with and apply franking credits.

As explained in para 35 of the Thomas Nominees case:

" In short, the Deed empowers the trustee to separately deal with franking credits so that they may be applied for the benefit specifically of any one or more of the beneficiaries. The Deed enables the trustee to stream various categories of income among the beneficiaries so as to result in different taxation outcomes for those beneficiaries. The Deed treats the separately identifiable taxation benefit that is a franking credit as income of the Trust Property that is capable of distribution."

What next?

Clearly, the views of the ATO on this issue will be critical. In the meantime, the importance of carefully and precisely drafting and reading the Deed cannot be overstated. Streaming is not dead - yet - but practitioners need to be mindful of the care needed when dealing with the issues here.

[ Brett Davies is co-author, with his colleague Tim Pepper, of the Estate Planning chapter of the Thomson Reuters Australian Financial Planning Handbook.]

(extracted from Thomson Reuters Weekly Tax Bulletin 4 - 28/01/11)

Estate Planning: beware of failing to consider business structures

- by Brett Davies, Civic Legal, Perth

With an ageing population, estate planning is becoming a bigger and more important issue by the day. This has been accentuated in recent times by the increase in retirement savings due to compulsory superannuation. Because of this increased wealth, tax-effective estate planning is of increasing importance to people contemplating the distribution of their assets upon their death.

There is always a place for "simple" Wills that focus only on the gifting of assets on death. However, comprehensive estate planning ensures the beneficiaries of deceased estates have the greatest flexibility to manage their entitlements. Well structured estate planning allows beneficiaries to take advantage of income tax savings to delay the imposition of de facto death duties such as CGT and to minimise stamp duty.

In all this, practitioners need to ensure they cover the bases.

It might seem trite to say (but is not always appreciated) that a Will needs to be prepared with a holistic understanding of the testator's business structures.

Estate Planning is more than just a Will

Put simply, a Will can never deal with every asset a person owns, although that is a good place to start. Assets a Will automatically deals with include:

property held in the testator's sole name;
property held as tenants in common;
property received as a beneficiary of a trust;
property the testator is entitled to as a shareholder of a company.

Assets a Will can deal with (but only if the testator so elects ) include:

superannuation benefits;
life insurance benefits;
who controls the testator's family trust (although it is not recommended that a Will provide for this - it is best to do this through the family trust).

What a Will cannot deal with includes:

assets held as joint tenants;
who controls the testator's company when they die (if they are a director);
who gets the assets of trusts the testator controls.

As many assets are not automatically controlled by a Will, having a valid Will in place is only half the battle.

To ensure a client's estate planning is complete, look out for business structures. What should the adviser be vigilant about?

What should the accountant and adviser look for?

Old Family Trusts

No succession planning - Many old family trusts don't have succession planning for the Appointor. So, who controls the family trust when the Appointor dies? That is one tricky (and expensive) exercise for the trustees and beneficiaries to figure out. It is better to update the family trust and make things certain now.
Flawed succession planning - "Upon the Appointor's death, then the Appointor is their legal personal representative". I cringe when I see this sentence in (what is usually a schedule) to a family trust. Why? Well, it is sometimes unclear who the "legal personal representative" of an Appointor is. It may take months to get a Grant of Probate on the Will to figure this out. The other problem is that a Will can be challenged - which makes the trust less certain. So, what happens if the Appointor dies, and leaves someone outside the family as executor? As legal personal representative, that person becomes the Appointor of the family trust. The person can then distribute all the trust assets to himself or herself as a beneficiary. The widow and children of the Appointor are left penniless. It's a horrible situation, but I've seen it happen.
No tax-saving measures in the family trust - trustee powers should be updated (by updating the deed) to allow for streaming (while this can still be done), take advantage of Bamford and more. However, if the trust deed is extremely old (1994 and earlier), it may be better to instruct a lawyer to update the trust.

Update Company Constitution

A Company Constitution is a legal document, drafted when a company is set up. It needs to be updated from time to time to take advantage of any new provisions in the laws that apply to the company.

Key person insurance

Does your client's business rely on the profitability of a key person? If so, do they have Key Person insurance?

In general, premiums for "keyman" insurance will be deductible if the policy was taken out to protect revenue items: see Carapark Holdings Ltd v FCT (1967) 115 CLR 653 and Ruling IT 155. However, if the policy is taken out to protect against a capital loss (eg to pay a sum to the key employee's estate on her or his death), the premiums will not be deductible. An apportionment of the premiums may be required.

It is advisable to have minutes that give supporting evidence of the purpose in acquiring the insurance policy.

Business Succession Planning

Sadly, many don't get exposure to the benefits of a documented and funded Business Succession Plan. Clients work hard to build up the value of their business. If something happens, they need to quickly realise and transfer the interest to the remaining business partner. A Business Succession Plan does this. Business succession plans are as flexible as you want them to be. They don't just have to cover death - they can cover bankruptcy, illness, jail, or even retirement. It allows you to get out of the business.

There are many ways to fund the buyout. These include cash payment, establishing a sinking fund, borrowing funds and vendor finance. The most common, however, is insurance. The insurance can be held in 4 ways:

Self-own.
Cross-own.
Insurance Trust.
Superannuation.

If you have to narrow Business Succession Planning down to one word, it is "certainty". You need certainty of funding and certainty of purchase price.

[ Brett Davies authors the Estate Planning chapter of the Thomson Reuters Australian Financial Planning Handbook. The Handbook also contains excellent information on small business succession planning.]

(extracted from Thomson Reuters Weekly Tax Bulletin 52 - 10/12/10)

Gearing and SMSFs: problems abound

- by Brett Davies, Civic Legal, Perth

The Superannuation Industry (Supervision) Amendment Act 2010 has amended the SIS Act with the aim of reducing the risks for superannuation funds investing in limited recourse borrowing arrangements (eg instalment warrants). It seeks to ensure that the recourse of the lender (or any other person) against the superannuation fund trustee for default on the borrowing is limited to rights relating to the acquirable asset: see 2010 WTB 23 [889].

The new rules governing limited recourse borrowing by self-managed super funds (SMSFs) are causing plenty of concern. In this article, after a little background, I have tried to answer some basic questions about the rules.

Prior to the amendments, s 67 of the SIS Act prohibited trustees of regulated super funds from borrowing money, except in certain limited situations. The instalment warrant exception in s 67(4A) of the SIS Act, introduced in 2007, permits super fund trustees to borrow money on a limited recourse basis (provided the conditions in s 67(4A) are met) to acquire any asset a fund is not prohibited from acquiring directly. However, the Government considered that market developments since these amendments had led to practices that raise prudential concerns with the use of such limited recourse borrowing arrangements by super funds.

The amending Act has repealed the provisions in s 67(4A) of the SIS Act and replaces it with a new s 67A (limited recourse borrowing arrangements) and s 67B (replacement assets). These new provisions seek to ensure that:

the recourse of the lender (or any other person) against the superannuation fund trustee for default on the borrowing is limited to rights relating to the acquirable asset;
the asset within the arrangement can only be replaced in prescribed circumstances that arise from owning the original asset; and
the borrowing is referable and identifiable only over a single asset (excluding money) or a collection of assets which are identical and are treated as a single asset.

So, the new law limits borrowing arrangements to a single asset.

The new rules apply from 7 July 2010. That sets the scene.

Now let's look at some issues that may cause concern.

No subdivision of land while loan in place

It is common for a SMSF to buy land for sub-division. The ATO states that the land cannot be carved up until the limited recourse loan is extinguished. The Explanatory Memorandum to the amending Bill specifically stated that subdividing land is a "replacement asset". Unlike say "repairs", "replacement assets" of real estate are not allowed in bare trusts. So, there are no new surprises here.

Buying "off the plan"

Someone who buys property off the plan is buying a share in a piece of land and the building contract. Over time, one hopes that this turns into a property with its own title. In its Q&A document on limited recourse borrowing arrangements, the ATO says it is concerned that this is "improving" the asset. This is not permitted. A Specific Advice order from the ATO is required. These Specific Advice orders are brand new. The Specific Advice states the ATO's position. This is on how the super law applies to a particular SMSF. Such advice includes the "buying off the plan problem".

Bare Trust needs its own ABN?

The asset in the bare trust belongs to the SMSF. Therefore, the losses and gains are taxed in the hands of the SMSF. Similarly, to date, all bare trusts use the SMSF's GST registration: see GST Ruling GSTR 2008/3.

Now, the ATO states that the bare trust (for property) can never actually be a "bare trust". If the income is above the GST registration threshold limit ($75,000), the trust may have to have its own GST registration.

CGT when the asset is transferred to the SMSF?

If the asset is in a bare trust, then there is no CGT when the person eventually transfers it into the SMSF. However, if the ATO believes (for the same reason as its GST argument above) that the trust is not a "bare" trust, then it may seek to impose CGT on the trust - when there is a transfer of the asset into the SMSF. "Madness"!

It's not necessary to actually wind up the trust when the asset is paid off. It can stay in the bare trust. However, it may also breach of the in-house asset rule to keep the property in the bare trust without the limited recourse loan.

The ATO says it ignores this CGT issue, provided the bare trust holds the asset as a mere custodian. However, ATO ID 2010/185 has highlighted a situation where a financial institution that prepared its own trusts has not done this. The ATO ID considered the situation where trustees of an SMSF entered into a borrowing arrangement on 15 July 2010 whereby a corporate trustee of a holding trust would acquire a residential property from a party unrelated to the SMSF. The trustees (that is, members) of the SMSF would be the directors of the corporate trustee of the holding trust. To facilitate the acquisition, one member of the fund borrows money from a financial institution and on-lends the money to the SMSF for investment into the holding trust. Under the terms of the arrangement, the corporate trustee of the holding trust holds the residential property on trust for the SMSF subject to a charge in favour of the financial institution to secure the loan to the member. In this situation, the ATO considers that the trustee of the SMSF contravenes s 67(1) of the SIS Act as it fails to meet the requirements of s 67A of the Act.

Car parking and storage room in strata properties

When an apartment is purchased, it often includes a car park and some storage. SMSF gearing only allows one asset to be placed in one bare trust. Is another limited recourse loan agreement and bare trust needed for the car parking bay as well? This is ridiculous! This is clearly all one asset. However, in its Q&A document, the ATO has only come out and said it "may" be one asset.

The ATO says it is probably only one asset where the "incident ancillary asset [is] of a very small value". Sadly, it then states that "strata title with an accessory car park and commercial premises over more than one title" may not be one asset. The ATO needs to consider each acquisition on a case-by-case basis.

The ATO suggests that those concerned could apply for a Specific Advice order.

Mum lends SMSF the money?

Question: Does a SMSF contravene s 109 of the SIS Act if it borrows money from a related party under a limited recourse borrowing arrangement? What if it is on terms favourable to the SMSF?

Answer: Neither breaches SIS. However, the terms cannot be more favourable to the related party than would be the case had the parties dealt at arm's length. There is no contravention of s 109 if the terms are more favourable to the SMSF: see ATO ID 2010/162

Mum and dad guarantee the debt?

Question: Can mum and dad guarantee the limited recourse loan?

Answer: Yes, a borrowing arrangement that includes a guarantee to the lender by a related party of the SMSF satisfies the SIS Act: see ATO ID 2010/170.

Borrowing by the SMSF trustee must satisfy the requirements of former s 67(4A) of the SIS Act where a related party of the SMSF has given the lender a personal guarantee as part of the arrangement.

Doubtless, there will be continuing calls for clarification of many issues surrounding these new rules. Hopefully, this article has shed some light on a few issues.

[ Brett Davies is one of the authors of the Thomson Reuters Australian Financial Planning Handbook.]

(extracted from Thomson Reuters Weekly Tax Bulletin 44 - 15/10/10)

Incorporating: Wojtowicz Kelly Legal, Brett Davies Lawyers, Gibson Tovey & Associates, Jan Simpson Settlements, All Property Conveyancing