Since late 2007, a Self-Managed Superannuation Fund (“SMSF” or “Fund”) has been allowed to borrow money for investment purposes following the introduction of an additional exception to the general borrowing prohibition – one that continues to exist under superannuation law.

This additional exception to the borrowing prohibition is provided in the form of a limited recourse type of borrowing.

In essence, the relevant asset is held on trust to provide limited security for the outstanding loan, but the benefits of the ownership (such as rent or dividends) flow directly to the Fund. If the Fund defaults on the loan, then the rights of the lender are limited to the asset which is the subject of the borrowing, and the Fund’s loss is limited to the loss of the beneficial interest in the asset and any payments made prior to the default.

Arrangements entered into on or after 24 September 2007 and before 7 July 2010, allowed a Fund to invest in certain borrowing arrangements involving borrowing money to acquire a permitted asset. Those arrangements must meet the conditions stipulated by the law in former subsection 67(4A) of the superannuation law – referred to as Instalment Warrants.

Those conditions continue to apply to limited recourse borrowing arrangements that were entered into before 7 July 2010, however new rules apply to new arrangements entered into on or after 7 July 2010 – referred to as Limited Recourse Borrowing Arrangements (“LRBAs”).

 

How The Arrangement Works

  1. An SMSF arranges to borrow money on a limited recourse basis, which it then transfers to a Holding Trust, along with its contribution to the purchase price.
  2. The Holding Trust would then arrange to purchase and hold the asset on trust for the SMSF.
  3. In this case, the SMSF would receive the beneficial interest in the asset and would be able to instruct the Trustee in relation to the asset.
  4. Once the SMSF repays the loan it can then arrange for the legal ownership of the asset to be transferred from the Holding Trust to the Fund.

 

 

What Can The Holding Trust Invest In?
Any investment that the superfund could hold itself can be purchased by the Holding Trust i.e. residential property, business real property, shares, managed funds.


What Can The Holding Trust Invest In?

The usual rules apply:

  • Must be purchased on arm’s length basis
  • Restrictions apply for assets purchased from a related party in the normal way (e.g. can’t buy residential property from the member or a related party).

Who Can The Lender Be?

  • A Bank
  • A Margin Lender
  • The member or a Related Party (i.e. the member can be their own lender either as an individual or a trust)
  • If the lender is a related party lender the loan should have a commercial interest rate. You should seek some advice about what is applicable in your situation.

 

Arrangements entered into on or after 24 September 2007 and before 7 July 2010

An SMSF is not prohibited from borrowing money, or maintaining a borrowing of money, providing the arrangement entered into satisfies each of the following conditions:

  • The borrowed monies are used to acquire an asset which the Fund is not otherwise prohibited from acquiring.
  • The asset acquired (or a replacement asset) is held on trust (the holding trust) so that the Fund receives a beneficial interest in the asset.
  • The SMSF has the right to acquire legal ownership of the asset (or, if applicable, the replacement asset) by making one or more payments after acquiring the beneficial interest.
  • Any recourse that the lender has under the arrangement against the SMSF Trustee is limited to rights relating to the asset acquired (or, if applicable, the replacement asset). For example, the lender can have the right to recover outstanding amounts where there is a default on the borrowing by repossessing or disposing of the asset being acquired under the arrangement, but cannot have the right to recover such amounts through recourse to the Fund’s other assets.

 

Arrangements entered into on or after 7 July 2010

An SMSF is not prohibited from borrowing money, or maintaining a borrowing of money, providing the arrangement entered into satisfies each of the following conditions:

  • The borrowed monies are used to acquire a single asset, or a collection of identical assets that have the same market value (that are together treated as a single asset), which the Fund is not otherwise prohibited from acquiring (called the ‘acquirable asset’). The new law makes it explicit that borrowed money applied to expenses incurred in connection with the borrowing or acquisition (such as loan establishment costs or stamp duty), or expenses incurred in maintaining or repairing the acquirable asset, is allowed.
  • The borrowed monies are not applied to improving an acquirable asset.
  • The acquirable asset is held on trust (the holding trust) so that the SMSF Trustee receives a beneficial interest in the asset.
  • The SMSF Trustee has the right to acquire legal ownership of the acquirable asset by making one or more payments after acquiring the beneficial interest.
  • Any recourse that the lender or any other person has under the arrangement against the SMSF Trustee is limited to rights relating to the acquirable asset. This limitation applies to rights directly or indirectly relating to a default on the borrowing and related charges or directly or indirectly relating to the SMSF Trustee’s rights in respect of the acquirable asset (for example, rights to income from the asset).
  • The acquirable asset is not subject to a charge other than as provided in relation to the borrowing by the SMSF Trustee.
  • The acquirable asset can be replaced by another acquirable asset that the SMSF is not otherwise prohibited from acquiring, but only in very limited circumstances as listed in the super law.

 

Self-Managed Superannuation Funds Ruling SMSFR 2012/1

The Australian Taxation Office released on 23 March 2012 its views on the limited recourse borrowing arrangement provisions. The Final Ruling explains the key concepts of what is a ‘single acquirable asset’, maintaining or repairing the acquirable asset (as distinguished from improving it); and when a single acquirable asset is changed to such an extent that it is a different (replacement) asset.

While the borrowings under the limited recourse borrowing arrangements cannot be used to improve an acquirable asset, the ATO says money from other sources could be used to improve (or repair or maintain) that asset. However, any improvements must not result in the acquirable asset becoming a different asset.

 

Single acquirable asset

Factors relevant in determining that what is being acquired is a single object of property, include:

  • the existence of a unifying physical object, such as a permanent fixture attached to land, which is significant in value relative to the overall asset value; or
  • whether a State or Territory law requires the two assets to be dealt together.

The following do not meet the ‘single acquirable asset’ provisions:

  • two or more adjacent blocks of land wanting to be sold together;
  • farmland with multiple titles; or
  • apartment with separate car park (unless titles cannot be assigned or transferred separately).

 

Repairs maintenance and improvements

Money other than borrowings can be used to fund improvements (or for repairs or maintenance).

An SMSF can use the cash within the fund to undertake improvements. Any improvements must not result in the acquirable asset becoming a different asset (replacement asset).

It will be important to consider the asset’s qualities and characteristics at the time the SMSF entered into limited recourse borrowing arrangement. The ATO has clearly indicated that restoration or replacement using modern materials will not amount to an improvement.

 

Replacement asset

Any alterations or additions that fundamentally change the character of the asset will result in a different asset being held on trust.

An asset becomes a different asset for example through subdivision, a residential house built on land, and change of zoning (residential to commercial).

There are various examples outlined in the Ruling that demonstrate where such improvements don’t create a different asset, including:

  • one bedroom of house converted to home office
  • house burnt down in a fire and rebuilt (regardless of size) using insurance proceeds and SMSF
  • funds
  • compulsory acquisition by government on part of property; and granny flat added to back of property

 

As borrowing is not treated as a contribution, there is no age restriction on who can use the strategy. However, borrowing is not for everyone and each member should seek advice on the appropriateness of a gearing strategy for their risk profile.  It is important to remember that if you borrow money you have to pay it back.

At McQueen Group, we have a specialist team that can provide you with legal and taxation advice on the structures involved and help you to understand both current and future tax implications if your Fund is considering to borrow money on a limited recourse basis.

 

 

McQueen Financial Group is a corporate authorised representative of Total Financial Solutions Limited. AFSL No. 224 954, ABN 94 003 771 579. This information is of a general nature only and does not consider your investment objectives, financial situation or particular needs. You should not act on any information in this report without first consulting a professional investment adviser in order to ascertain whether the information and any investment decision is appropriate. This information is believed to be accurate however no warranty of accuracy or reliability is given in relation to any advice or information contained, and neither TFSA or its Representatives and officers, agents or employees of either of the aforementioned shall not be held liable for any loss or damage whatsoever arising in any way for any representation, act or omission, whether express or implied (including responsibility to any persons by reason of negligence).