Australia: The final word from the ATO on limited recourse borrowing arrangements

Last Updated: 4 July 2012
Article by Andrew O'Bryan, Rebecca James and Mark Payne

This Ruling explains the following key concepts relevant to the application of the limited recourse borrowing arrangements under sections 67A and 67B of the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act):

  1. what is an 'acquirable asset' and a 'single acquirable asset';
  2. 'maintaining' or 'repairing' the acquirable asset as distinguished from 'improving' it; and
  3. when a single acquirable asset is changed to such an extent that it is a different (replacement) asset.

The superannuation law permits a borrowing arrangement if the money borrowed is applied for the acquisition of a single acquirable asset and that asset is held in a holding trust. The fund trustee acquires a beneficial interest in the asset and the right of recourse of the lender in the event of default is limited to the acquirable asset held in the holding trust. By making one or more payments after acquiring beneficial ownership the fund trustee has the right to acquire legal ownership.

Key message

The key messages from the ruling are that the fund trustee:

  1. can use the existing assets of the fund to improve an asset. However, where the improvements alter the character or function of the asset, the fund trustee will breach the superannuation law. Therefore, the fund trustee cannot substantially develop the property until the borrowing has been repaid;
  2. can draw down on the borrowing to maintain or repair the asset, however, the terms of the arrangement must provide for additional draw downs; and
  3. alterations or additions made by a tenant to a rental property that is held under a borrowing arrangement do not result in a different asset if the fixtures remain the property of the tenant.

The underlying theme is that the Commissioner of Taxation appears to be against property development being undertaken in a borrowing arrangement. Conceptually, it is a fine distinction between building a house on vacant land and rebuilding a house on newly vacant land. The basis is the approach taken by the Commissioner of essentially considering the use of the property.

Importantly, the ruling does not consider the application of the in-house asset rules if an asset continues to be held on trust once the borrowing has been repaid. Therefore, there is a question of whether section 71(8) of the SIS Act would continue to exempt the trust arrangement from the in-house asset provisions. We recommend taking tax advice before transferring the asset to the fund from the holding trust.

Repairing and maintaining an asset

Importantly, improvements cannot be made with borrowed funds and cannot be to such an extent that they alter the character or function of the asset. SMSFR 2012/1 gives the following example of what constitutes maintenance and what is an improvement:

Residential property A fire damages part of the kitchen. Restoration of the damaged part of the kitchen with modern equivalent materials or appliances would constitute repair of a part of the entire asset being the house and land. If superior materials or appliances are used it is a question of degree as to whether the changes significantly improve the state or function of the asset as a whole. For example, the addition of a dishwasher would not amount to an improvement, even if a dishwasher was not previously part of the kitchen, on the basis that this is a minor or trifling improvement to the state or function of the asset as a whole. If the house was extended to increase the size of the kitchen this would be an improvement. If as well as restoring the damaged part of the internal kitchen a new external kitchen was added to the entertainment area of the house the external kitchen would be an improvement.

Improving an asset

A replacement asset not provided for in section 67B of the SIS Act will breach the borrowing provisions. SMSFR 2012/1 gives the following example on whether an asset is sufficiently improved or altered such that it would be considered a replacement asset.

Vacant block of land on single title A vacant block of land is subdivided resulting in multiple titles. One asset has been replaced by several different assets as a result of the subdivision.

Single acquirable asset

The term 'property' is not defined in the SIS Act and therefore, has its ordinary meaning. 'Property' describes:

  1. proprietary rights; and/or
  2. the physical object of the proprietary rights (ie land or machinery).

It is necessary to consider both the legal form and substance of the asset acquired.

Factors relevant in determining whether an asset is a single acquirable asset are:

  1. the existence of a fixture attached to the land which is permanent in nature, not easily removed and significant in value relative to the asset's value; or
  2. whether under a State or Territory law the two assets must be dealt with together.

Each of the following circumstances would not, without more, be sufficient to support a conclusion that what is being acquired is identifiable as a single object of property:

  1. there is a physical object situated across two or more titles and that physical object:
    1. is not significant in value relative to the value of the land; or
    2. is temporary in nature or otherwise able to be relocated or removed relatively easily therefore not preventing the titles being dealt with separately;
  1. a business is being conducted on two or more titles; or
  2. the assets are being acquired under a single contract because the vendor wants to deal with the assets as a package or the lender will only lend over a group of assets.

Acquiring a 'renovator's delight'

The fund trustee can acquire an asset in a run down state and repair the asset using borrowed funds without breaching the superannuation law.

However, the greater the state of deterioration at the time of acquiring the asset, the more likely it is that subsequent alterations or additions to that asset will be considered to be improvements.

Subsequent draw downs for repairs

Subsequent draw downs to repair an asset the fund trustee borrowed to buy will give rise to additional borrowings. However, the borrowing arrangement will continue to comply with the superannuation law if:

  1. the additional borrowings are applied in maintaining or repairing the asset held under the borrowing arrangement; and
  2. the draw downs are provided for under the terms of that arrangement.

Money other than borrowings used to improve an asset

A fund trustee can use the existing fund assets to improve the single acquirable asset brought under a borrowing arrangement. However, any improvements must not result in the acquirable asset becoming a different asset.

Replacement assets

Importantly, alterations or additions made by a tenant to a rental property that is held under a borrowing arrangement do not result in a different asset if:

  1. the alterations or additions do not fundamentally change the character of the asset; or
  2. the fixtures remain the property of the tenant.

Property development

If a contract is entered into for an off-the-plan purchase of a strata titled unit and under the contract a deposit is required upon entering into the contract with the balance payable at settlement after the unit is built and strata titled, each payment is applied for the acquisition of that strata titled unit. Providing that the strata titled unit is a single acquirable asset the deposit and the balance payable at settlement may be funded under a single borrowing arrangement.

A similar outcome results if the contract entered into is for the purchase of a single title vacant block of land along with the construction of a house on that land before settlement occurs. In this situation the deposit paid upon entering into the contract and the balance payable upon settlement is applied for the acquisition of land with a completed house on it. The deposit and the balance payable at settlement may be funded under a single borrowing arrangement.

If an option is acquired for an off-the-plan purchase of a house on a single title block of land, the single acquirable asset is the option. The money applied to acquire the option may be funded under a borrowing arrangement subject to complying with the superannuation law. However, the subsequent acquisition of the house and land upon exercise of that option would need to be funded under a separate borrowing arrangement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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