SMSF borrowings: Government rejects LRBA ban

Direct borrowings by superannuation funds via limited recourse borrowing arrangements (LRBAs) are safe (at least for the next 3 years), following the Government’s decision to reject the Murray Financial System Inquiry recommendation to ban or restrict LRBAs. This is welcome news for trustees of self-managed superannuation funds (SMSFs) who have faced uncertainty about the future of such borrowing arrangements which have become popular for investments in direct property and shares.

In releasing its response to the Murray Inquiry on 20 October 2015, the Government accepted all but one of the Inquiry’s 44 recommendations (it disagreed with the LRBA restriction recommendation). The Government also included 6 additional measures that it says “are consistent with the Inquiry’s underlying philosophy”.

The final report of the Murray Inquiry, released in December 2014, included a recommendation to restore the general prohibition on direct borrowings by superannuation funds by removing the current exception for LRBAs in s 67A of the SIS Act on a prospective basis. In its response to the Murray Inquiry, the Government said that it did not agree with this recommendation. While the Government noted that there are “anecdotal concerns” about LRBAs, it said that the data is not sufficient to justify a significant policy intervention at this time.

However, the Government will commission the Council of Financial Regulators and the Tax Office to monitor leverage and risk in the superannuation system and report back to Government after 3 years. According to the Government, this timing will allow recent improvements in ATO data collection to wash through the system. The agencies’ analysis will be used to inform any consideration of whether changes to the borrowing rules might be appropriate at a future date.

SMSF property purchases via LRBAs — proceed with caution

Despite the Government’s “green light” for LRBAs, a decision to establish an SMSF and invest in property using an LRBA is not one to be taken lightly. A borrowing arrangement is only permitted where it complies with the strict rules under the SIS Act. This means that each step in the process of establishing an SMSF and putting in place an LRBA (and the property investment itself) must strictly comply with the full range of superannuation rules.

Given the complexity involved, retail investors considering property investments via an SMSF should obtain independent advice in terms of their personal obligations as SMSF trustees. Before committing to purchase a property it is vital to plan ahead to avoid any adverse SIS compliance issues or tax consequences down the track. Severe penalties (and criminal sanctions) can result for breaching the SIS Act, not to mention the transaction costs to unwind a non-compliant structure. Therefore, an SMSF trustee should seek assistance from a professional adviser in relation to the borrowing agreement and the establishment of a holding trust (also known as a custody trust). Such planning will help to ensure that the arrangement complies with all relevant laws and receives the intended tax treatment in the years ahead.

LRBA checklist

Before committing to purchase a property via an SMSF, consideration should be given to the following LRBA issues:

  • Finance approval obtained for the loan before committing to purchase.
  • LRBA is consistent with the fund’s trust deed.
  • Selected property is consistent with fund’s investment strategy in terms of risk, return, diversification and liquidity.
  • Borrowing arrangement documentation compliant with s 67A of the SIS Act.
  • An SMSF may be liable for non-arm’s length income (taxable at 47%) under certain related-party LRBAs.
  • Custody trust structure itself must comply with s 67A of the SIS Act.
  • Initial deposit for the property should be paid by the SMSF trustee.
  • The asset must be “held on trust” so that the SMSF trustee acquires a beneficial interest. Obtain specific advice on the proper timing for signing the contract, and nominating the trustee of the custody trust, under each state and territory’s duty laws. See our ClearLaw article on this topichere.
  • The property must be transferred directly from the vendor to the custody trust trustee on settlement.
  • Trustee of the SMSF must not at any stage hold the asset (until the loan is repaid).
  • An off-the-plan purchase can be funded under a single LRBA but an option to acquire an off-the-plan property may need a separate LRBA for any subsequent acquisitions.
  • A separate LRBA may be required where property comprises several legal titles.
  • Take care with fixtures, series of titles and future subdivisions.
  • Money borrowed under an LRBA can be used to repair an asset (but not to improve it).
  • The asset must not be subject to a charge or mortgage, except as required under s 67A of the SIS Act.
  • The in-house asset exemption for LRBAs relies on the asset being the only property of the custody trust (eg a bare trust).
  • Any recourse of a lender against the SMSF trustees for a default on the borrowing must be limited to the underlying asset.

In conclusion, the complexity involved with LRBAs means that SMSF trustees will need to employ a methodical approach (generally with the assistance of a professional adviser) to ensure compliance with the superannuation borrowing rules.

Originally posted by Stuart Jones, Thomson Reuters in November 2015

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