Tuesday, February 21, 2023

SMSF borrowing arrangements and business succession: a modern life** story

We recently had an adviser seeking guidance in relation to business succession arrangements where business property was to be purchased by two parties via their self-managed superannuation funds, with a limited recourse borrowing arrangement.

The three main approaches that we explained are as follows, noting that the preferable solution depends on the exact commercial circumstances:
  1. As the intention with the borrowing arrangements is normally that they are self-funded, some business owners choose to leave the structure in place and have an unfunded agreement (for example, a unit holder’s agreement) regulating how the parties will conduct themselves if one of the principals passes away.
  2. In other words, the deceased’s estate would treat the ownership interest in the building as an arm’s length investment and would effectively maintain that interest until the other owner had sufficient funds to acquire the interest, or alternatively, the entire property was sold to a third party.
  3. The above approach is predicated on the assumption that the super fund of the exiting principal otherwise has sufficient assets to pay the death benefit.
  4. A second alternative is for each principal to self-own insurance to pay out any debt referable to ‘their’ interest in the underlying property, noting that practically any such insurance must be held outside the superannuation funds. This is because if it is owned via the super fund, the insurance proceeds are simply added on receipt to the exiting member’s entitlements that must be paid as a lump sum or pension (and can therefore not be used to help reduce debt).
  5. If this approach is adopted, the succession arrangements can proceed essentially along the same lines as set out above, or the estate of the deceased principal can acquire an interest in the property using the insurance proceeds (and triggering the potential tax and stamp duty consequences on the sale).
  6. Finally, each principal can obtain sufficient insurance to clear the entire debt. The buy-sell arrangement would require that 50% of the proceeds are paid to each principal (or their estate). The underlying property can then be dealt with as set out above, or alternatively, steps can also be taken to ensure that the relevant share of the property is transferred to the surviving principal’s benefit.
  7. This last pathway is often used in business succession arrangements and is referred to as the ‘hybrid’ approach (see previous View posts explaining the model). This said, the involvement of superannuation funds does create additional, potentially significant, complications.
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** For the trainspotters, the title of today's post is riffed from the Regurgitator song ‘Modern Life’.

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