LRBA setup costs – does the super fund need to pay for them?

A resounding yes. Let's explore why.

When a self-managed superannuation fund (SMSF) acquires an investment (eg a property) using a limited recourse borrowing arrangement (LRBA), a number of setup costs are usually incurred. For example, costs to incorporate a company that will act as the custodian or bare trustee, responsible for holding legal title for the investment. As well as legal fees to document the custodian/bare trustee is holding the investment for the benefit of the super fund. These are all costs associated with the fund’s acquisition of the geared investment.

And this is why it is vital for the super fund to be invoiced and pay for all associated costs. Since 1 July 2018, the concept of what qualifies as non-arm’s length income was expanded and includes situations where in gaining or producing income, the fund incurs less expenditure (including no expenditure) than would otherwise have been expected if the parties had been dealing on an arm’s length basis. This includes expenditure incurred to acquire an asset (including associated financing costs).

If a super fund member or other entity in the family group has been invoiced and paid for the LRBA setup costs instead and not been promptly reimbursed by the super fund, the fund may have non-arms’ length expenditure in respect of the investment acquired under the LRBA. This may cause any income derived from the geared investment (including any capital gains) to be classified as non-arm’s length income and taxed at 45%. As the shortfall in costs relates to expenses incurred in acquiring a specific investment, there is no limit imposed on the amount of additional tax payable.

Alternatively, if the fund was invoiced but that invoice was paid by the member or other entity and not reimbursed by the super fund, the cost will be treated as a contribution to super and tested against the member’s contribution caps.

Note, costs to incorporate the custodian/bare trustee company and document the custodian/bare trust arrangement will generally not be deductible to the super fund as they are expenses of a capital nature. SMSFs are generally unable to make use of the “blackhole” provisions so these costs would be added to the cost base of the underlying asset.

Be sure to put our Super Intensive Day into your calendar now. With options for online as well as face to face events, our sessions will include real life examples on how the non-arm’s length expenditure rules can impact common SMSF transactions. Register your interest here.