Bare Trust

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Contents

  • What is a Bare Trust? 
  • Legal and Beneficial Interests in the Asset Structure 
  • Financial and Borrowing Considerations 
  • Acquisition of Single Acquirable Assets 
  • Legal Framework and Compliance for Limited Recourse Borrowing Arrangements (LRBA) 
  • The Role of the Bare Trustee 
  • Declaration of Trust Requirements for SMSF Bare Trusts 
  • Documentation and Legal Formalities 

What is a Bare Trust? 

A Bare Trust is a simple yet effective legal arrangement used within Self Managed Superannuation Funds (SMSFs) primarily for property investments. In this structure, the trustee of the Bare Trust holds the legal title to the property, while the SMSF, as the beneficiary, holds the beneficial interest.  

This separation of ownership is crucial, especially when SMSFs engage in borrowing under a Limited Recourse Borrowing Arrangement (LRBA). The Bare Trust structure ensures that if the SMSF defaults on the loan, the lender’s recourse is limited to the asset held in the Bare Trust, thereby protecting the other assets within the SMSF. 

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Legal and Beneficial Interests in the Asset Structure 

In the context of an SMSF using a Bare Trust: 

  • Legal Interest: The Bare Trustee legally owns the asset on paper but does not have any beneficial interest in it. The trustee’s role is essentially passive, involving holding the title until the loan is repaid or the property is disposed of. 
  • Beneficial Interest: The SMSF, as the beneficiary, enjoys all the benefits deriving from the asset, including rental income and capital gains. Once the loan is fully repaid, the legal title can be transferred from the Bare Trust to the SMSF, making it the outright owner of the property. 

Financial and Borrowing Considerations 

Borrowed funds within an SMSF can only be used under specific conditions as outlined by the superannuation laws. These conditions include: 

  • Purpose of Borrowing: The funds must be used to purchase a single acquirable asset, which can be maintained or repaired but not improved using borrowed money. 
  • Loan Terms: The loan terms must comply with the strict guidelines set out under LRBA, ensuring the loan is a limited recourse loan where the lender’s rights are restricted to the asset financed by the loan. 

Acquisition of Single Acquirable Assets 

A single acquirable asset refers to an identifiable asset, or collection of identical assets, that have the same market value and are treated as a single asset. This concept is critical in ensuring that SMSFs do not use borrowed funds to acquire assets that could complicate the investment strategy and increase risk exposure. As per Australian laws, the following regulations apply in this context: 

  • Define what constitutes a single acquirable asset. This includes not only physical properties but also other types of assets that meet the criteria of having a single title or identical features. 
  • Outline the permissible scope of maintenance and repairs on the asset using borrowed funds, as opposed to improvements, which must be funded by other means. 

The strategic use of Bare Trusts in SMSFs for property acquisitions under LRBAs allows for significant investment opportunities, provided the arrangements adhere strictly to the superannuation laws. This structure not only facilitates effective asset management within SMSFs but also ensures compliance and protection of member benefits. 

Legal Framework and Compliance for Limited Recourse Borrowing Arrangements (LRBA) 

Limited Recourse Borrowing Arrangements (LRBAs) are a specific financial structure permitted under section 67A of the SIS Act, allowing SMSFs to borrow money for investment purposes. The defining characteristic of an LRBA is that the lender‘s recourse in the event of a default is limited to the asset purchased with the borrowed funds, thus protecting the other assets within the SMSF from financial claims. 

Current Legal Requirements for LRBAs

Under current superannuation law, several compliance requirements are established to ensure that SMSFs engaging in LRBAs are operating within legal boundaries: 

  • Super Law Compliance: SMSFs must adhere to specific provisions under superannuation law when structuring LRBAs, ensuring that all financial dealings align with the legal requirements designed to protect the interests of fund members. 
  • Loan and Lender Compliance: The relationship between the SMSF trustees and the lender must not create compliance issues. For instance, the terms of the loan agreement must conform strictly to the stipulations defined under superannuation laws. 
  • Asset Holding Under LRBA: The asset acquired under the arrangement must be held in a separate holding trust. This holding trust arrangement ensures that the legal title of the asset is separated from the SMSF trustees until the loan is fully repaid. 

Special Rules for Asset and Income Handling

  • Income Entitlement: The SMSF must be entitled to a majority, if not all, of the income generated from the asset held under LRBA, which contributes to the fund’s overall investment return. 
  • Holding Trust Structure: The superannuation law does not prescribe a specific type of trust for holding the asset under an LRBA. However, the trust must be structured in a way that complies with the overarching legal requirements for superannuation funds. 
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The Role of the Bare Trustee 

The Bare Trustee plays a pivotal role in the management of a property acquired by an SMSF under a Bare Trust arrangement. The primary duty of the Bare Trustee is to hold the legal title to the property on behalf of the SMSF, which holds the beneficial interest.  

This role involves ensuring that all decisions and actions regarding the property align with the trust deed and the legal obligations to the SMSF beneficiaries. The Bare Trustee must act impartially, avoid conflicts of interest, and prioritise the interests of the SMSF members in all transactions. 

Appointment of Corporate Bare Trustees 

Appointing a corporate trustee rather than an individual can offer several advantages, including limited liability, continuity in administration despite changes in membership, and a streamlined process for recording property titles. It is recommended that SMSFs consider the structure of their Bare Trust to determine if a corporate trustee could offer greater efficiency and compliance with fiduciary duties, especially in managing complex property portfolios. 

Declaration of Trust Requirements for SMSF Bare Trusts 

The Declaration of Trust is a critical document that must be tailored to meet both legislative requirements and the lender’s criteria. Its structure is pivotal in defining the roles and responsibilities within the Bare Trust arrangement involving an SMSF. 

Essential Provisions of the Declaration of Trust

  • Role of the Bare Trustee as Apparent Purchaser: The declaration must clearly state that the Bare Trustee is listed as the apparent purchaser in the property transaction, not the Super Fund Trustee. This distinction helps in defining the legal boundaries and responsibilities in the property acquisition. 
  • Source of Purchase Money: It must be documented that all funds for purchasing the property were sourced from the Super Fund Trustee, who is the beneficial owner, along with any loans secured for this purpose. The Bare Trustee does not provide any of the purchase funds, reinforcing their role as merely a title holder. 
  • Property Held in Trust: The declaration needs to affirm that the Bare Trustee is holding the property solely in trust. This implies that the Bare Trustee has no beneficial interest in the property and holds it only until specific conditions are met. 
  • Obligations of the Bare Trustee: The Bare Trustee’s responsibilities are limited to acting on instructions from the Super Fund Trustee. This includes adherence to any directives related to property management or dealings until the loan is fully paid off. 
  • Restrictions on Property Transfer: A specific instruction should be included stating that the Bare Trustee must not transfer the property back to the Super Fund Trustee until all payments due under any associated loan are completely settled. 
  • Documentation and Security: The declaration must outline the requirement for the Bare Trustee to sign all relevant documents concerning the financial arrangements made by the Super Fund Trustee. This is to ensure that the property can be appropriately used as security for the loan. 

Caution Against Overreaching Guarantees

Special attention is required if the lender includes terms like guarantee in the financial agreements. Such guarantees must be scrutinised to ensure they do not inadvertently extend to other assets of the Super Fund. A broader guarantee could potentially invalidate the entire arrangement under specific sections of the superannuation act, such as Section 67(4A), which emphasises the limited recourse nature of these loans. 

In drafting the Declaration of Trust, clarity, compliance with the Act, and alignment with lending requirements are essential to safeguard the SMSF’s interests and ensure the legality of the Bare Trust arrangement. This document serves not only as a formal acknowledgement of the roles and responsibilities but also as a protective measure against legal pitfalls. 

The Declaration of Trust must be executed promptly when the SMSF acquires a property through a Bare Trust to avoid potential double stamp duty charges. Adequate and timely documentation ensures that the state revenue authorities recognise the proper party for stamp duty purposes, thus avoiding double taxation. 

How the Apparent Purchaser Exemption Affects SMSFs

In general Australian stamp duty law, the apparent purchaser exemption may apply when a property is purchased in the name of one party while another party is the true owner (beneficial owner).  

For SMSFs, ensuring that the Bare Trust arrangement is properly documented can help clarify the relationship between the legal title holder (Bare Trustee) and the beneficial owner (SMSF), which is crucial for qualifying for any potential exemptions and avoiding unnecessary stamp duty. 

Documentation and Legal Formalities 

Establishing a Bare Trust within an SMSF requires meticulous documentation to ensure compliance with legal standards and to facilitate smooth operations: 

  • Trust Deed: Outlines the agreement between the Bare Trustee and the SMSF, specifying the terms under which the property is held. 
  • Loan Agreement: If property acquisition involves financing, particularly under Limited Recourse Borrowing Arrangements, the terms of this borrowing should be documented. 
  • Property Title Documents: These should accurately reflect that the Bare Trustee holds the legal title for the property on behalf of the SMSF. 
  • Declaration of Trust: Essential for confirming the Bare Trustee’s role and detailing the SMSF’s beneficial ownership. 

Importance of Correct Documentation 

Accurate and comprehensive documentation is critical in managing a Bare Trust. Proper documents support compliance with both tax and legal regulations, help in resolving potential disputes, and ensure transparency in the operation of the SMSF. They are also vital in audits and reviews by regulatory bodies, helping to establish that all actions and transactions are performed in accordance with the rules governing SMSFs and Bare Trusts.  

Ensuring that all paperwork is in order can protect the SMSF from legal infringements and financial penalties. 

This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.