The use of loan offsets against limited recourse loans in SMSFs

I had some feedback in another thread about the use of offsets in SMSFs but I really need something specific before I go to a private ruling.

Here are two scenarios;

SCENARIO 1
SMSF IP1 on bare trust - settled at $550k
SMSF limited recourse loan 1 on IP1, $440k
SMSF offset against loan 1, $50k - intention to use these funds as a cash buffer to maintain the property, carry out repairs, cover vacancy etc. The balance would stay at roughly this level on average - topped up monthly from rental income and concessional super contributions.

SCENARIO 2
As above but the SMSF offset against loan 1 contains $440k, thereby eliminating interest charges. Intention with the offset cash is to act as a cash buffer (as above) and 8-12 months later, settle a second IP (deposit previously paid from SMSF) along with a second limited recourse loan. Lets say we remove $250k for this purpose leaving the following situation;

IP1 - limited recourse loan 1 for $440k, offset $190k
IP2 - limited recourse loan 2 for $360k, offset $160k

Question 1: at all times in both scenarios are all interest charges deductible for the SMSF?

Question 2: is the use of the offset as imagined in scenario 1 going to result in a breach of the SiS act or other relevant legislation?

Question 3: is the use of the offset account as imagined in scenario 2 going to result in a breach of the SiS act or other relevant legislation?

Question 4: in the event that scenario 1 doesn't breach the SiS act, but scenario 2 does is there specific guidance from the ATO that explains why?

Question 5: in the event that both scenarios don't breach the SiS act, is there any guidance from the ATO that supports this?

Question 6: have you (either a SMSF trustee, SMSF Auditor, Lawyer or Accountant with SMSF experience) experienced a negative outcome with the ATO in relation to the use of offsets as described above and why?

I'm happy to pay for advice as long as it comes in the form of a letter that I can reference come annual return / audit time.

I have spoken to a number of people that suggest that both scenario 1 & 2 won't breach the SiS act, however, this could simply be because there are at least 2 significant lenders who offer the offset facility within SMSFs (ie these individuals assume the strategy is legal as a result of a lender's product)

I think it is pretty clear that if there was a way to re-draw additional repayments made to a limited recourse loan in a SMSF it would breach the single acquirable asset rule and therefore breach the SiS act. Presumably this is because those re-drawn funds could be used to purchase additional assets.

What isn't clear to me is whether the same would apply to the use of offset funds - my layman logic says it should be fine, but that ultimately is useless if the ATO don't agree.

Trev
 
In scenario 2 I may suggest that there could be a concern. The terms of the bare trust will require (an absolute entitlement) that when the loan is repaid that the property pass to the fund.

Now I know someone will post and say that the loan isn't repaid. Yes I know that. But it could be. I don't see a SISA breach as such.

If the loan is maintained and the offset balance equals the loan balance there could be some issues of trust that may need advice. The position for the bare trust is that the loan isn't even being repaid - At all. That isnt the intention within the bare trust and may run contrary to the terms of the trust. The ATO has never addressed this issue and are aware of the possibility. The ATO do have a SMSF Rulings system but in many cases the ATO refuse to give their views. This may well be such a case since it concerns law that is not tax law.

It may be something to raise with a SMSF specialist lawyer before considering a SMSFR. DBA Lawyers may be a good start.

There may be other strategies if the property is paid off. Just confining your thinking to the offset and loan may be limiting some options.
 
In scenario 2 I may suggest that there could be a concern. The terms of the bare trust will require (an absolute entitlement) that when the loan is repaid that the property pass to the fund.

Now I know someone will post and say that the loan isn't repaid. Yes I know that. But it could be. I don't see a SISA breach as such.

If the loan is maintained and the offset balance equals the loan balance there could be some issues of trust that may need advice. The position for the bare trust is that the loan isn't even being repaid - At all. That isnt the intention within the bare trust and may run contrary to the terms of the trust. The ATO has never addressed this issue and are aware of the possibility. The ATO do have a SMSF Rulings system but in many cases the ATO refuse to give their views. This may well be such a case since it concerns law that is not tax law.

It may be something to raise with a SMSF specialist lawyer before considering a SMSFR. DBA Lawyers may be a good start.

There may be other strategies if the property is paid off. Just confining your thinking to the offset and loan may be limiting some options.

Hi Paul, that is a good point, I hadn't thought about the potential impact on the bare trust itself. Note that my intent is to maintain the 100% offset amount for say 12 months prior to settling another property.

I have checked the deed and other documents and can't see anything that would suggest a problem.

A variation to scenario 2 would be to deposit into the offset 95% of the loan balance to avoid fully offsetting the loan amount. In this situation interest would be charged and interest payments made (albeit greatly reduced).

The bare trust documentation is DBA's and I have a relationship with them already so I'll speak to them about it.

Trev
 
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