SMSF Limited Recourse Borrowing Arrangements (LRBA)
There has been a great deal of discussion in recent months on borrowing by SMSFs since the Financial System Inquiry report release last December recommending to the Government to ban all borrowing by SMSFs. The ATO has since released two interpretative decisions around how they apply the non-arm's length provisions to LRBAs involving loans from related entities to an SMSF. More recently the Government has announced that they did not agree with the Financial System Inquiry's recommendation to prohibit LRBAs by SMSFs. They do not consider the data sufficient to justify significant policy intervention. The ATO has been advised to monitor leverage and risk in the superannuation system and report back to the government after 3 years.
An SMSF is not prohibited from borrowing money if the arrangement entered into satisfies the conditions specified under the Superannuation Industry (Supervision) Act (SISA).
Section 67A(1) of SISA provides an exemption from the basic prohibition on SMSF borrowing where:
- the borrowing is applied for the acquisition of a single acquirable asset.
- the borrowing is to be used to purchase an asset that is held on trust for the SMSF.
- the SMSF receives a beneficial interest and a right to acquire the legal ownership of the asset through the payment of instalments.
- the loan is applied to an asset that the fund is permitted to acquire under the superannuation law.
- the lender's right to recoup against the loan is limited to recovery from the specific asset.
Borrowed monies cannot be used to improve an asset, therefore, you cannot borrow money to renovate an existing property or to develop land owned by the SMSF. However, trustees may make subsequent draw downs under an LRBA for the purposes of maintaining or repairing the asset subject to the LRBA. The asset can be replaced by another asset that the SMSF is allowed to acquire but only in very limited circumstances.
Single Acquirable Asset
The most common asset purchased by trustees through an LRBA is real property. It is important to ensure that the property is consider to be a 'single acquirable asset'. The term "acquirable asset" is defined as any form of property, other than money, that the trustee is not otherwise prohibited from acquiring. Property can be either proprietary rights (e.g. titles of ownership) or the physical objects of property rights (e.g. land or machinery). It is necessary to consider both when determining whether money borrowed under an LRBA has been applied for the acquisition of a single acquirable asset. The existence of multiple titles may suggest that the property is not a single asset. Where the property is considered to be multiple assets, separate LRBA's will be needed for each asset. Where there is a legal or physical impediment to the property that prevents the different titles from being sold separately, the multiple parcels of the property will constitute a single asset.
Establishing an LRBA
When entering into an LRBA within your SMSF, it is important to ensure that all parties are aware of what is involved in terms of costs, documentation and compliance with SISA.
The trustees will need to review the fund's trust deed to ensure the borrowing is permitted and the fund's investment strategy should be reviewed to incorporate decisions about how the investment will be financed and through which lender. Some lenders prefer to deal with an SMSF that has a corporate trustee, therefore, a change of trustee may be required.
A security trust deed will need to be established (with a corporate trustee), this is the entity that will hold the asset acquired under an LRBA. The security trust deed is between the security trust and the SMSF. The security trust will be the legal owner of the asset and should therefore be listed on any contract documentation. The security trust is not seen as a separate entity for tax purposes and therefore no accounts or returns are maintained for the security trust.
When funding the purchase of the asset, the deposit must be paid from the SMSF and the SMSF should take out a cover note to insure the asset from the contract date. Payment on settlement will likely be made with the borrowed monies and the SMSF may wish to contribute additional funds.
All transactions in relation to the loan repayments, income from the asset and expenses incurred are made by or to the SMSF. Loan repayments need to be identified as principal and interest. Once the payment of the final instalment is made, the legal ownership of the asset must be passed to the SMSF.
An example of the LRBA structure is below: