What is the difference between SMSF and bare trust?
A self-managed superannuation fund (SMSF) cannot legally borrow by itself and thus must use a legal vehicle known as a Bare Trust to buy the asset with borrowing while showing the beneficial interest in the residual being held solely by the SMSF.
To explain in simple terms what a ‘trust is’ there are three basic requirements being a:
- trustee – controller/manager of the asset
- beneficiary – is the real owner of the asset
- trust asset (a trust cannot exist without holding some asset)
One of the simplest examples of a trust is when a parent sets up a bank account and manages it on behalf of and for the benefit of a child. The trustee is the parent whose name appears on the bank account as the “legal controller”. The “beneficial” owner of the bank account is the child. The money in the bank account is the trust asset.
Bare Trust
A trustee of a bare trust holds a trust asset on behalf of the beneficiary. The bare trustee has to manage the trust asset prudently on behalf of the beneficiary or lawfully as directed by the beneficiaries. Generally, the only duty of the bare trustee is to transfer the legal ownership of the trust asset to the beneficiary when requested by the beneficiary. It does not generally operate, hold a bank account or lodge a tax return.
SMSF Trust
A SMSF trustee holds the member’s balance on trust. The assets of a SMSF must be legally held on behalf of the SMSF by the SMSF trustee except in relation to a limited recourse borrowing arrangement (LRBA). The beneficiaries of the SMSF are the members. The SMSF trust deed governs the activities of the trustee in addition to the Superannuation Laws and Regulations (SISA). A SMSF trustee operates a bank account, pay fund expenses, deposit contributions and income, arrange for financial statements, the SMSF Tax Return and an annual audit, make investment decisions, pay member benefits and maintain proper fund records. It is crucial to ensure SMSF assets are kept separate from the trustee’s (or director of the corporate trustee) personal assets.
Difference between SMSF and Bare Trust
The distinction between a bare trust and a self-managed super fund (SMSF) lies in their responsibilities. A bare trust has a single obligation, which is to pass the legal ownership of the trust asset to the beneficiary. In contrast, an SMSF has multiple responsibilities, all centred around the sole purpose of providing retirement benefits to its members.
SMSF borrows money to purchase a property
The SISA rules allow a SMSF to borrow money under a LRBA provided, amongst other requirements, the asset is held on trust and the SMSF has the right to acquire legal ownership when the borrowings are repaid. Generally, a bare trust, which is often referred to as a holding trust or a custodian, is used when a SMSF borrows to purchase a property.
The bare trustee cannot be the same as the SMSF trustee as there is no trust relationship when the legal owner and the beneficial owner are the same.
