A bare trust is a legal document that separates legal and beneficial ownership of properties purchased by Self-Managed Super Funds (SMSF) using a Limited Recourse Borrowing Arrangement (LRBA). It is also known as custody, custodian or holding trust.
This document is required to ensure that the trust complies with the Superannuation Industry (Supervision) Act 1993. It also helps SMSFs avoid paying double taxes when executed correctly.
It is important for the LRBA and bare trust to be correctly set up to avoid contravention, which could result in the fund losing almost half of its assets in fines.
Here is a guide on how to correctly set up the bare trust.
Things to do before setting up a bare trust
Before borrowing money, all trustees must be aware of the terms and conditions of the investment. All discussions related to the loan and purchase must also be documented.
Once all trustees agree to the proposed asset acquisition, the trust must ensure that the purchase will not breach the trust deed or SISA and state laws. The trustees must do the following:
Double check the deed of trust
Trustees must ensure that purchase of the asset passes the sole purpose test. The acquisition should also be aligned with the SMSF investment strategy, as written in the trust deed.
Know and understand state laws
It is imperative that the trustees aware of all the state laws related to the purchase of properties, especially when it comes to the format of documents.
Some states require trustees to indicate the bare trustee as the purchaser, while others want both the bare trustee and SMSF trust’s name. Northern territories, on the other hand, require the use of certain words in the contract.
Go over the lender’s requirements
Banks and other legitimate lenders usually have their own set of requirements for an LRBA.
Most of the time, lending parties want to see proof of the SMSF’s financial health to confirm its capability to repay the loan. A healthy stream of contributions from members provides assurance that the LRBA will not default.
Likewise, some lenders require additional security or a guarantor, so it is the trustee’s duty to meet the requirements—as long as they comply with SISA regulations.
Once complete, the trustees must set up the bare trust.
Setting up the bare trust
The Australian Taxation Office (ATO) requires the creation of a separate trust for the sole purpose of holding legal ownership of the purchased asset. This means:
- A corporate SMSF is not allowed to use its existing corporation as a trustee., It must establish a new company to serve as the legal owner of the property.
- This new company’s sole purpose is to hold the property and sign contracts and agreements related to it
- The bare trustee may also be an individual, but individual trustee SMSFs should check the lender’s requirements before moving forward with an LRBA.
- Most lenders prefer corporate trustees to ensure loan payment continuity, even during circumstances that can disrupt SMSF activities in an individual trustee set up.
Once the bare trustee has been nominated, appointed or established, the SMSF must create a ‘Bare Trust Declaration’ to establish the terms of the asset acquisition. Here are some things to consider with regard to the declaration:
- It must explicitly state that the trust is set up for the purchase of the specific asset, and that the bare trustee is only holding legal ownership of the property for the benefit of the trustee;
- If the asset to be acquired is real property, its full address must be written in the declaration or deed;
- The bare trustee must be the signatory in all documents concerning the purchase of the asset;
- The SMSF trustee who initiated the LRBA must be explicitly stated as the borrower in all documents;
- Since SISA regulations already state that the acquired asset may only be transferred when the loan has been repaid in full, the declaration may indicate that the transfer may commence at any time.
The trust should also keep documents showing that all the money for loan payments and other expenses comes from the borrower.
Correct order for signing documents
The State Registry Office must stamp the bare trust deed for property acquisitions. It is important to know the State’s required order of documentation before signing any of the documents. because signing in incorrect order may result in double stamp duty.
- Western Australia and Victoria is not particular about signing order. Both states allow contracting parties to sign any of the documents anytime.
- South Australia, Queensland and Northern territories require the bare trust deed to be dated and signed before the contract of sale (bare trust comes first).
- The Australian Capital Territory, New South Wales and Tasmania requires the contract of sale to be signed and dated before the bare trust deed (deed of sale comes first).
The list above contains current state requirements with regard to the schedule of dating and signing LRBA-related documents. It is important to note that the regulations may change, so it is the trust’s duty to stay updated on prevailing rules at the time of purchase.
This information has been sourced from the Foley's List, Bates Cosgrave and Brazel Moore Lawyers.