Until legislative changes in September 2007, the SMSF structure was viewed as being deficient and unattractive to a certain degree, because of their inability to borrow money to acquire assets. The Commonwealth Government and Australia Taxation Office (ATO) through various legislative amendments and rulings have been addressing this issue enabling SMSFs to borrow from banks and or related parties on a Limited Recourse Borrowing Arrangement (LRBA) to fund the acquisition of assets
The ATO has provided some guidance with the recent release of a draft ruling (SMSFR 2011/D1) which has brought greater clarity to the application of the key concepts relating to SMSF LRBA, particularly in relation to:
- how to structure this type of borrowing arrangement;
- the structuring of real property asset acquisitions under a LRBA;
- the types of assets which may be funded;
- permissible works in connection with any real property within a SMSF LRBA as it clarifies what is an improvement versus a repair;
- the view that improvements to real property may be made using the SMSF's cash reserves or insurance proceeds; and
- what constitutes a "single acquirable asset".
The ATO ruling provides investors, legal advisors and lenders with greater confidence to enter into such transactions but does not diminish the importance of obtaining professional advice to ascertain the costs, the appropriate documentation and compliance with the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA).
Compliance with Superannuation Laws
Section 67A(1) of SISA provides for a general exemption from the basic prohibition on SMSF borrowing where the following the conditions are met:
- the borrowing is applied to a single asset;
- the borrowing must be applied to the acquisition of the asset;
- the asset being acquired must be held in a custodial trust with the SMSF as the sole beneficiary of the asset;
- the SMSF has the right to acquire the legal ownership of the asset through the payment of instalments after acquiring a beneficial interest in the asset; a lender's right to recoup against the loan is limited to the recovery from the specific asset; and
- no other encumbrance can be placed over the acquired asset apart from the mortgage registered by the lender.
- The trustee of the SMSF will need to also comply with all other SISA requirements such as, amongst others, the trustee acting at all times in compliance with the general laws and with due diligence and care; the asset to be acquired must an asset permitted to be acquired under SISA; the transaction does not breach any rules such as related party transactions; and that of the investment strategy of the SMSF
How does a LRBA Work
The establishment of a SMSF LRBA will require the following:
- review of SMSF documentation;
- a loan facility to be established from either the third party lender or related party lender (such as members of the SMSF); and
- the establishment of a custodial trust (with a corporate trustee) to hold the asset under LRBA.
This arrangement allows for all beneficial entitlements such as investment returns to flow to the SMSF whilst the SMSF will be liable for meeting the loan obligations.
Limited recourse to the acquired asset
Recent amendments to SISA provides protection to SMSFs to ensure that if the SMSF defaults on a loan the lender's rights are limited to the "acquired asset" held in the custodial trust as the lender has no recourse to any other assets that are held within the SMSF.
The rules surrounding LRBA are complex and professional legal advice ought to be sought prior to entering into such an arrangement as the imposition of penalty tax for a non-complying SMSF will apply.
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