2. Look through treatment after the debt has been paid?

Once the borrowing under the limited recourse borrowing arrangement has been repaid, will the statutory look through treatment continue to apply?  This depends on the correct interpretation of a particular provision (namely 235-840(b)).  The ATO has previously removed the need to wind-up the arrangement once the borrowing has been repaid.  Why the look through treatment should cease upon the repayment of the borrowing is not obvious (at least to us).

In our opinion the statutory look through treatment will continue to apply once the borrowing has been repaid. The text of the particular provision is “until the borrowing has been repaid, the arrangement is covered by …s67A..”.  The better interpretation of the particular provision is that while the borrowing is on foot the statutory look through provisions will only apply if the borrowing satisfies the requirements of s67A (or its predecessor).  The provision does not mean that the statutory look through treatment will cease to apply on the borrowing being repaid.  This is supported by the explanatory memorandum which states that the look through treatment will continue to apply (paragraph 3.47 of the explanatory memorandum).

If advisers or trustees are concerned as to whether the statutory look through treatment continues after the borrowing has been repaid, then there are three courses open to them: first structure (or restructure) the arrangement so that look through tax treatment applies independently of the statutory provision; secondly, transfer the acquired asset to the SMSF trustee as soon as the borrowing is repaid; or, thirdly retain a small debt so that the statutory look through treatment continues to apply until the acquired asset is sold or transferred to the SMSF trustee.

The first and best response is to structure the arrangement so that look through tax treatment automatically applies without reliance on the statutory provisions.  SUPERCentral’s legal advisers, Townsends Business & Corporate Lawyers, have always drafted their limited recourse borrowing documents so that the holding trust is tax transparent meaning that:

• the income generated by the acquired asset is taxed in the hands of the SMSF trustee and not in the hands of the trustee of the holding trust as the SMSF is presently and indefeasibly entitled to the income of the holding trust;

• any capital gains or losses arising on the disposal of the acquired property are treated as gains or losses of the SMSF trustee and not that of the trustee of the holding trust (as the SMSF trustee is absolutely entitled to the acquired asset as against the holding trustee);

• any taxable supplies arising by leasing the acquired property are taxable to the SMSF trustee and not the trustee of the holding trust (as the holding trust is a bare trust for GST purposes); and

• the holding trust is exempted from lodging tax returns as the SMSF trustee has  an absolute and indefeasible entitlement to both the capital and income of the holding trust (in this case the holding trust is a transparent trust for the purposes of the ATO Practice Statement Law Administration PS LA 2002/2).  

Where the documents supporting the limited recourse borrowing arrangement have not been drafted to achieve the same effect as the Townsends’ documents, SMSF advisers and SMSF trustees may need to retain a small debt (or refinance with a small loan principal when the debt is repaid) to retain an entitlement to the statutory look through treatment.

If SMSF advisers or trustees are in doubt or uncertain of the tax consequences of their limited recourse borrowing documents if and when the borrowing is repaid, Townsends’ can assist by legally reviewing those documents and where appropriate preparing any necessary amending documents.

The second response is to immediately transfer title of the acquired property to the SMSF trustee.  We can provide a detailed technical paper on transfer of the acquired property, please contact SUPERCentral on 02 8296 6266 or email: info@supercentral.com.au.
 
The third response is to retain a small debt on the acquired property.  This can be achieved by repaying most of the borrowing but not all.  If for commercial reasons the lender is not prepared to continue with borrowing with a small principal – the borrowing could be refinanced with a related party loan (but on arm’s length terms and conditions).  In this situation the borrowing is maintained and so the statutory look through provision will continue to apply.