Although self-managed super funds are generally not permitted to borrow, the super rules do provide some exceptions. The most publicised exception to the ‘no borrowing’ rule is the ability to enter a limited recourse borrowing arrangement. (I explain the other main borrowing exceptions in the article SMSF basics: Can my DIY super fund borrow money?).
Any LRBA must satisfy special conditions
According to the ATO, if your super fund chooses to use a limited recourse borrowing arrangement (LRBA), then the arrangement must satisfy the following conditions:
- The fund uses the borrowed monies to purchase a single asset, or a collection of identical assets that have the same market value. For example, presumably, the intent of this rule is that you can borrow to purchase the
- The fund cannot use the LRBA monies improve a purchased asset.
- The SMSF
- The SMSF trustees have the right to acquire the legal ownership of the asset my making one or more payments
- Any recourse that the lender (or other party) has under the LRBA against the
- Replacing the asset subject to the LRBA is possible in very select circumstances. For example, if a company undertakes a share split or unit split, or there is a company takeover or merger.
Note: If cash is received as part of the share split or company takeover, then the replacement asset doesn’t satisfy the pre-existing LRBA conditions. Subdividing a single title into a series of titles also doesn’t satisfy the LRBA conditions.
Q & As – courtesy of the ATO
The ATO has kindly produced a batch of Q &As for SMSF trustees on LRBAs. The document is well worth a read. I have included a sample of the Q & As below, but you can read the entire ATO document by clicking on this link.
1. Are only marketed instalment warrant products allowable for SMSFs under the limited recourse borrowing rules?
The ATO says: “No. Borrowing is allowed under any arrangement that meets the requirements of the super law, not just financial products marketed as instalment warrants. Conversely, it does not automatically follow that a product marketed as an instalment warrant meets the conditions of the super law.”
2. Are only instalment warrant investments over listed securities allowable for SMSFs under the limited recourse borrowing rules?
The ATO says: “No. The rules allowing limited recourse borrowing are not limited to investments in instalment warrants traditionally offered by financial institutions where the underlying asset is a listed security. Other arrangements or products are allowed if they satisfy all of the requirements of the super law.”
3. Can an SMSF trustee refinance a limited recourse borrowing without contravening the super law?
The ATO says: “Yes, provided the re-financed arrangement meets the requirements of section 67A of the SISA. Section 67A explicitly allows re-financing of a borrowing (including any accrued interest) under an arrangement if the new borrowing arrangement is over the acquirable asset from the first arrangement (including an asset from the first arrangement that is a replacement asset under section 67B of the SISA) and no other acquirable asset. Where a new trust is created to hold the asset, SMSF trustees must ensure that the asset is transferred directly to that new trust and that the SMSF does not temporarily obtain title to the asset at that time, otherwise a contravention of the super law will occur. “
The ATO also deals with LRBAs in place before 7 July 2010 (when the new laws were introduced). If you have a LRBA that was in place before 7 July 2010 then I strongly recommend you read the ATO’s Q & A document. Click here to access the document.
4. Is an SMSF allowed to borrow from a related party?
The ATO says: “The law does not prohibit the lender from being a related party. However, SMSFs must continue to comply with other legislative requirements. For example, the SMSF must satisfy the sole purpose test and comply with existing
5. Can a related party borrow on a full recourse basis and on-lend the money to the SMSF under a limited recourse borrowing arrangement at a higher rate of interest?
The ATO says: “Yes, provided:
- the limited recourse loan to the SMSF by the related party is appropriately documented
- the SMSF is not charged higher than an arm’s length rate of interest for borrowing
- the arrangement under which the SMSF borrows from the related party otherwise meets the requirements of the super law.
For arrangements entered into on or after 7 July 2010, the super law specifically prohibits the asset being acquired by the SMSF trustee under the arrangement from being used as security for the borrowing of the related party.”
6. Does an arrangement that permits capitalisation of interest or other borrowing charges satisfy the super laws?
The ATO says: “Yes. The super law (specifically, subparagraph 67A(1)(a)(i) of the SISA) applying to these arrangements explicitly provides that, under a limited recourse borrowing arrangement, the SMSF trustee can apply borrowed money towards expenses incurred in connection with the borrowing.
- Example: Dividend income to reduce loan principal. Under an arrangement that otherwise meets the requirements of the super law, any dividend income on the underlying share is applied first in reducing the loan principal amount. At one point in the year, the loan principal amount is increased by the capitalisation of the interest amount. This is permitted under subsection 67(4A) applying to arrangements entered into before 7 July 2010, because each amount so drawn down is applied as a cost of acquiring the underlying share. It is also permitted under section 67A applying to arrangements entered into on or after 7 July 2010.
- Example: Dividend income paid to the investor. Under an arrangement that otherwise meets the requirements of the super law, all dividend income on the underlying share is paid to the investor. The loan is drawn down annually and applied to pay the interest amount. This is permitted under subsection 67(4A) applying to arrangements entered into before 7 July 2010, because each amount so drawn down is applied as a cost of acquiring the underlying share. It is also permitted under section 67A applying to arrangements entered into on or after 7 July 2010.”
7. Can an SMSF member provide a personal guarantee to the lender in a limited recourse borrowing arrangement?
The ATO says: “Yes, provided the guarantors rights against the principal debtor (the SMSF trustee) are limited to rights relating to the asset being acquired under the arrangement.
Under the super law applying to these arrangements, the recourse of the lender or any other person against the SMSF trustees in connection with, or as a result of, a default on the borrowing (either directly or indirectly) must be limited to rights relating to the asset that is being acquired under the arrangement. This means, for example, that for an arrangement to meet the requirements of the super law, any guarantor must not have general rights of indemnity against the principal debtor (the SMSF trustee) that might crystallise in the event of a call on the guarantee. However, the guarantor may have rights of subrogation of the lender’s rights (that is, the right to exercise the lender’s limited rights of recourse to the asset being acquired under the arrangement) that might crystallise in the event of a call on the guarantee.”
8. Can an SMSF trustee borrow under a limited recourse borrowing arrangement to build a house on vacant land owned by the fund?
The ATO says: “No. An existing SMSF asset cannot be put into a limited recourse borrowing arrangement. The giving of a charge over an existing asset of the fund (the vacant land), as would generally occur under such arrangements, would contravene the super law.”
9. Can shares issued under a dividend reinvestment plan be retained in the arrangement?
The ATO says: “No. For an arrangement over a collection of shares, if additional or bonus shares are issued in respect of that collection of shares, they cannot simply be added to the collection as that is not a permitted replacement asset. If the arrangement is to continue, the additional shares need to be transferred out of the arrangement – for example, in a similar way that a cash dividend might be.”
Note: The Q & As listed above are just a sample of the Q&As you can find on the ATO website. If your fund is considering a LRBA then I encourage you to check out the ATO material. If you have a pre-existing LRBA (in place before 7 July 2010), then you must check out the Q&As because slightly different rules apply to LRBAs in place before 7 July 2010. Click on this link to access the Q &As.
Other useful ATO documents on LRBA
The ATO has also produced four other useful documents on LRBAs. Click on the links below for access:
- ATO ID 2010/162 (Self managed Superannuation Fund: limited recourse borrowing arrangement – borrowing from a related party on terms favourable to the self managed superannuation fund)
- ATO ID 2010/169 (Self managed superannuation fund: limited recourse borrowing arrangement – refinancing)
- ATO ID 2010/170 (Self managed superannuation fund: limited recourse borrowing arrangement – third party guarantee)
- ATO ID 2010/172 (Self managed superannuation fund: limited recourse borrowing arrangement – joint investors)
Important announcements from the Government
On 10 March 2010, the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP announced two proposed changes to the limited recourse borrowing rules in relation to superannuation:
- Only licensed advisers will be able to recommend and implement limited recourse borrowing arrangements.
- A superannuation trustee who enters into a limited recourse borrowing arrangement to purchase an asset, as permitted under the SIS Act, will be treated as the owner of the asset for income tax purposes, thereby averting the triggering of the capital gains tax rules when paying the final instalment.
The Government has subsequently released a discussion paper on these two proposed changes, and an exposure draft of the proposed legislation for these additional changes will soon be available.
