GUEST POST: Understand the state jurisdictions when establishing LRBAs


The ATO’s recent release of Taxpayer Alert – TA 2012/7, provide trustees and professionals with a timely reminder about acquisition of property using a Limited Recourse Borrowing Arrangement (LRBA) and also through related unit trusts.

Some of the examples of concern raised by the Commissioner in TA 2012/7 surrounding LRBAs suggest individuals are either:

  • oblivious to the appropriate legislative provisions; or
  • not seeking the appropriate advice prior to entering into the property acquisition.

Of most interest from the features that concern the Commissioner, was the following statement:

“The trustee of the holding trust is not in existence and the holding trust is not established at the time the contract to acquire the asset is signed” [Arrangement 1, item (c)]

Whilst this may be a true statement for some state jurisdictions, this is not necessarily the case across all States and Territories of Australia.  For example, Victoria’s conveyancing and stamp duty laws do not prohibit nor penalise parties when they incorporate and establish a Trust in contemplation of being the nominated party for a property transaction that is already on foot.  It is commonplace in Victoria for parties to be nominated to complete a property acquisition to which they were not the original party. Usually, the initial Contract of Sale provides a nomination provision. If this is not the case, there is a statutory provision that enables a nomination of the purchaser of a property in Victoria within 14 days of the date of settlement.  Any nomination is subject to the nominated party completing the transaction. If this not be the case the original purchaser is still liable to settle.

Additionally there is no stamp duty penalty if there is a nomination of a substituted purchaser that does not equate to a second sale.

The fact that the Custodial Trustee and the Bare Trust has not been established prior to the execution of the Contract for the property that is eventually acquired by the SMSF as law would be irrelevant in Victoria.

With a LRBA via nomination adhering to all of the provisions of section 67A & 67B of the SIS Act, it is difficult to determine what offends SIS or the ATO in respect of such arrangements?

The prohibition described by the ATO where the Custodial Trustee and the Bare/Holding Trust has not been established prior to the execution of the contract may in fact offend some State stamp duty provisions that would lead to double Stamp Duty.

The “lore” described by the ATO where the Custodial Trustee and the Bare Trust has not been established prior to the execution of the Contract may not be found offensive in Victoria.  I would submit that the Victorian courts would question the ATO’s motives by making such a statement.

Only time will tell, but invariably frightened parties will shy away from when a good real estate investment opportunity presents itself to a SMSF.

Written by Ian Glenister, Solicitor

Legal Officer & Co-founder, The SMSF Academy

State of play with SMSF Limited Recourse Borrowing Arrangements

Which direction will Treasury and the ATO head with Limited Recourse Borrowing Arrangements?

The use of Limited Recourse Borrowing within Self Managed Super Funds continues to capture the attention of trustees and advisers alike.

We are seeing some significant work being undertaken in this area of borrowing to provide greater clarity of section 67A & 67B introduced into the Superannuation Industry (Supervision) Act 1993 (“SIS Act”).

With this activity, I thought it appropriate to post an article outlining the current “state of play” in regards to SMSF Limited Recourse Borrowing Arrangements.  So where are we currently at with many of the ‘grey’ issues?

  • Definition of “Single acquirable asset” – the current ATO view of single acquirable asset for real property is based on its boundaries defined by legal title.  Therefore, the single acquirable asset definition is very restrictive as it does not allow for properties held over multiple titles including farmland and some commercial property.  A more common issue caught by this definition is the car-park attached to an apartment or office building that sits on separate title.  Where assets are inseparable, or where there is an ancillary asset of a very small value, the ATO may treat the assets as a single asset for the purposes of section 67A.  Previous information from the ATO has indicated that a car park does not meet this requirement.  It would be prudent to obtain a private ruling from the ATO where such inseparable or ancillary assets exist.
A workshop was conducted late last year by the ATO with selected representatives of the NTLG Super Technical sub committee to address issues impacting limited recourse borrowing arrangements.  The Institute of Chartered Accountants (“ICAA”) included as part of their submission for the ATO to adopt an accounting standards approach to identify what is a single acquirable asset.  The use of accounting standards looks at the “economic substance” of an asset, not simply the boundaries of legal title.  By taking this view it means that the component parts of an investment property are not looked at but instead they are treated as one whole asset.

It is my understanding that the ATO have taken this information on board and raised the issue back to Treasury as a technical priority issue.  Any change will need to balance the original policy intent of the changes in July 2010 with the current ‘logic’ provided by the industry.  As a result we are unlikely to receive any further information on the matter from Government until August or September this year.

Have you registered for the SMSF Limited Recourse Borrowing day?

  • Improvements regardless of source of funds are prohibited – arguably the most common question I get asked is whether the real property acquired can be improved using the super fund’s own money.  Regardless of the source of funds, any capital improvements would be in breach of the replacement asset rules contained within section 67B of the SIS Act.  Therefore if any capital works need to be undertaken on the property, they should be completed prior to purchase, otherwise at this stage we are stuck with only being able to repair an asset to its original state.
  • Repairs vs. Improvements – the already ‘grey’ issue within tax law now also resides within superannuation law with the introduction of section 67A(1)(a)(i) that allows the acquisition of an asset to include expenses incurred in maintaining or repairing the asset to ensure that its functional value is not diminished. The only guidance currently available is contained in Tax Ruling TR 97/23. The ruling applies a very rigid approach in determining what is a repair vs. improvement.

Read further information from my previous blog, are limited recourse borrowings beyond repair?

To understand some of the issues being confronted by the introduction of these changes to superannuation law and the application of TR97/23, let’s look at a few examples:

    • New hot water system — the replacement of a depreciable asset such as a hot water system would not be considered a repair for tax purposes. Accordingly, any new system would be capital and constitute a replacement asset?
    • Painting internal surfaces — if the painting involves a full refurbishment, which results in the interiors being changed, updated, upgraded or otherwise improved (i.e. the new asset is different either in form, quality or functionality than the original), the costs would be on capital account and therefore be in breach of the replacement asset rules.  If the painting merely puts the internal surfaces back to the condition that they were in, e.g. before the surface was damaged, the costs should be deductible as repair costs.
    • Replacing emergency lights — as with the hot water system, the new lights would generally be considered to be the replacement of depreciable assets and therefore not repairs.

I understand that issues regarding improvements to the acquirable asset have been discussed with Treasury as a priority technical issue.  We can only be hopeful that the ATO would not apply this very strict approach to real property owned within a SMSF (otherwise some tenants may be having cold showers!!)

  • Properties affected by natural disaster – with the significant impacts of floods, fires and other natural disasters over the past year, it was pleasing to see the Commissioner state that they would use their discretionary powers for a SMSF to retain its complying fund status (section 42A) to repair damaged properties, even where these repairs would constitute a replacement asset.

Refer to my previous post, replacing assets using limited recourse borrowings affected by natural disasters.

  • In-house assets – the ATO has made clear that in their view there will be a breach of the in-house asset rules if legal title is not transferred to the SMSF after the borrowing has ended.  By retaining the asset within the holding/bare trust, it will be an investment in a related trust.
  • Reviews of ATO Interpretative Decisions (ATOIDs) – expect the ATO to revisit ATOID 2010/162 – borrowing from a related party on more favourable terms to the SMSF.  This initial interpretive decision somewhat caught the industry by surprise with its initial views.  Further thought by the Regulator has suggested that they will go back to the drawing board on this ID to consider the arms-length requirements further and the impact of other areas of superannuation law where the SMSF obtains more favourable terms.  Refer to previous article, What interest rate can you charge your fund for a SMSF limited recourse loan?

These are just some of the mounting issues on the ATO’s plate that are needing to be dealt with on the issue of limited recourse borrowing arrangements.  

With an overlay of the Stronger Super support by the Federal Government to review limited recourse borrowing within two years (30 June 2013), it tempers some of the enthusiasm around for using this strategy within a self-managed super funds.  Hopefully we will see some light at the end of the tunnel shortly providing greater clarification to progress forward with this exciting strategy.

Download the SMSF Limited Recourse Borrowing day brochure to find out more information about the strategies and practical issues of using these highly effective arrangements within a Self-Managed Super Fund.

10 things about the latest stats on SMSFs

The Australian Taxation Office (ATO) has recently released (2 March 2011) their quarterly SMSF statistics to the end of December 2010.  A lot of attention is directed to these statistics about the continuing growth of the SMSF industry, but what are some of these statistics really telling us about self-managed super funds?

I outlined below 10 key things and my views about the latest statistics from the ATO:

  1. The average fund balance has now grown to $957,248. However, there are still more than a quarter of all SMSFs with balances of less than $200,000.  Conversely, we see a quarter of all SMSFs with more than $1 million.
  2. I predict that by the end of the 2013 calendar year, there will be a one (1) million SMSF members across 530,000 SMSFs.  These numbers are supported by consistent year on year % growth, which will see net establishments each year continue to grow at about 6-6.5% p.a.
  3. The most active growth is happening with SMSF in the range of $200 – $500k. The number of these funds is up 7% from the prior year, 2009 (in terms of the percentage of funds with asset balances in this range).  Whilst markets will have influenced these numbers to an extent, this growth will also be supported by younger entrants to the SMSF market (Gen X, inclusive of the 35-44 age bracket) who are looking for greater choice and control, including with strategies such as borrowing in super.
  4. Interestingly by way of comparison between the 2008 to 2009 financial years, listed shares as an asset range dropped from 34% to 26% of total fund assets.  Whilst market correction (GFC) will have influenced this, it also suggests that many trustees moved to more cautious investment strategy positions of cash and term deposits. To support this theory, cash and deposits increased to 23.22% from 20.25%.  I believe it shows that many trustees do take an “active” role in the management of the SMSFs.
  5. There is growing exposure to both residential and commercial property within SMSFs.  This will have predominantly come from interest levels in limited recourse borrowing arrangements.
  6. There appears to have been a ‘clean out’ of lower balance SMSFs (under $50k).  These funds will have either simply be wound-up (maybe by the ATO where no assets actually ever existed) or further contributions were made into the fund to improve their viability.
  7. There does appear to be new-comers to SMSFs in the $100 – $200k mark.  Many of these people will be likely to pursue direct investing arrangements to make the fund’s operations cost-comparative to an APRA fund (but providing greater choice).
  8. There is a significant decreasing trend in the number of SMSF wind-ups.  The number of wind-ups from 2008 (7,749 funds) to 2009 (3,502) has more than halved. Year-to-date 2010 figures to date suggest a further decline, which only supports the 6 – 6.5% net growth rates predicted above.
  9. Whilst there is a lot of industry-talk about the benefits of a “Family Super Fund” or “Enduring Family Super Fund”, the ATO statistics don’t support this as a concept, with decreasing numbers of funds having 3 or 4 members.  Four member funds now represent only 4.4% of the market.  Whilst these percentage changes are substantial across SMSFs, single member funds are growing to nearly a quarter of all SMSFs (22.8%).  I find this amazing that we having a growing trend in single member funds but a decreasing use of corporate trustees?  There could be many trustees setting themselves up a significant fall at an estate planning level!!
  10. Operating costs to manage SMSFs appear to be relatively constant, which means with growing account balances makes their costs in percentage terms very attractive.  This is likely to be as a result of a range of factors including efficiency gains in delivering the SMSF statutory obligations and more price-sensitive trustees (due to the GFC).

It will be interesting to watch the continued growth and evolving beast that is self-managed super funds…

Are limited recourse borrowings beyond repair?

Changes that took effect on 7 July 2010 for limited recourse borrowing arrangements don’t seem to have dampened the enthusiasm for people being attracted to the use of this strategy to acquire either residential or commercial property within a SMSF.

These changes have however introduced a more restrictive environment in holding property, in particular for those who wish to acquire with a view to making improvements to increase the future value of the property.  There are some concerns within the industry that a lack of understanding of these super laws may result in breaches of the requirements contained in section 67A & 67B of the SIS Act (click to read SPAA’s media release).

A key change to the borrowing rules is the inability to renovate or make improvements to an asset as this would fundamentally change the nature of the asset used as security by the lender.  This potentially increases the risk to the fund. However, money under a limited recourse borrowing arrangement applied for the acquisition of an asset can be used for expenses incurred in maintaining or repairing the asset, to ensure that its functional value is not diminished.

Drawing down on an existing borrowing

There now appears to be some inconsistencies between the ability to undertake repairs (initial or ongoing) of an asset purchased using a limited recourse borrowing arrangement and SMSFR 2009/2, which looks at the meaning of borrow money’ or ‘maintain an existing borrowing of money’ for the purposes of section 67 of the SIS Act.   This ruling treats each draw down as a separate and new borrowing.  This is confirmed in paragraph 93 of this ruling where:

93. The Commissioner also considers that each drawdown of funds from a loan facility or similar arrangement constitutes a separate borrowing, even if the facility or arrangement makes provision for redraws arising from earlier repayments.

Whilst the ATO agrees that it follows that each borrowing under a LRBA must meet the requirements of paragraphs 67A(1) (a) to (f), their view is to consider the arrangement as a whole, rather than each separate borrowing under that one arrangement.

For the purposes of satisfying section 67A(1)(a), it is sufficient if the borrowed money is used to repair the acquirable asset, whether the money is borrowed initially or later into the arrangement.  By taking the ‘whole view’ approach to the acquirable asset, the ATO does not regard a repair, or any materials or services used as an incident of that repair, to be an acquirable asset in their own right.

Initial Repairs

When looking at the acquisition of an acquirable asset such as property, the purchase price of an asset may be dictated by the current state of the property and its level of functionality.

The topic of initial repairs for tax purposes is contained within Tax Ruling TR97/23.  It outlines many of the issues in differentiating between capital and revenue expense for tax purposes.  But when considering the requirements of superannuation law (SIS Act), the timing of the deterioration is somewhat irrelevant in determining whether a borrowing can occur to rectify that deterioration (in accordance with s.67A).

It appears the issue is whether the activity is a repair according to ordinary concepts as compared to an improvement.  The discussion in TR97/23 is relevant, in particular paragraphs 83 to 87 when considering the ordinary meaning of ‘repair’.

The debate of what is repair and improvement has been around for a very long time with tax professionals.  It has been a “grey area” for a long time, and the introduction of this concept into limited recourse borrowing certainly adds a further layer of complexity.

To appreciate the level of interest and the ongoing questions and issues surrounding limited recourse borrowing arrangements, the last NTLG Super Technical Sub-Committee meeting conducted by the ATO recommended a workshop with member representatives of the professional bodies to work through these ever-increasing issues.

Therefore, expect to see a lot more information coming from ATO in 2011.

Click here to find out how to use borrowings within super for property development.

Would you be interested in attending an intensive day on SMSF limited recourse borrowing arrangements?  Click here to vote in our poll.

Buying “off-the-plan” with limited recourse borrowing arrangements

Recent media suggests rapidly growing interest in the use of limited recourse borrowing arrangements to acquire property using a Self Managed Super Fund.

One of the more common ways people are acquiring property is through “off-the-plan” (OTP) developments, whereby the SMSF signs a contract for the vendor to deliver at settlement a completed apartment.

How an OTP typically works

Under an OTP purchase, typically the vendor enters a contract with a builder to build the apartment and the purchaser merely enters the purchase contract for the completed apartment and land.  At the time of signing, there may still be the need to sub-divide the title and build the apartment.  Settlement is often delayed until a certificate of occupancy is issued for the apartment once it is completed and the building surveyor has signed-off that it complies with relevant planning, etc.

The ‘industry view’ is that such an arrangement as above for OTP is a purchase of a ‘single acquirable asset’ and not an improvement, in so far that the SMSF obtains a completed apartment pursuant to the contract at settlement. However, as always, it is the view of the Regulator that we most eagerly await for…

The ATO’s views

The recent minutes from the NTLG Superannuation Technical Sub-Committee, suggest that the Tax Office have not yet finalised their view on this matter (they are seeking further details).

However, what is interesting to note, is that the ATO will be looking at the timing of the borrowing being commenced, that is, has the borrowing started after the apartment is completed and strata-titled?

As a result, an such arrangement would need to keep in mind the following requirements:

  • The acquirable asset must be placed in the holding (bare) trust when the borrowing is commenced and held in trust while the borrowing is maintained.
  • If the acquirable asset is replaced by another asset in circumstances not listed in section 67B, or in a regulation made for the purposes of subsection 67B(8), then the arrangement must be terminated at or before that time or a contravention of subsection 67(1) results.

It appears that the ATO’s view is that if the borrowing is made to fund the deposit and to acquire what at that stage is merely a contractual right to acquire title in future property, then there is a risk that the replacement of that ‘right’ by the actual asset would be a breach of the limited recourse borrowing arrangement provisions.

It is imperative that for SMSF trustees (and their advisers) looking an OTP purchases closely consider (and obtain advice) the contractual arrangements of the acquisition when undertaking a limited recourse borrowing arrangement.

Note: A further article will follow next week about the latest on multiple titles with limited recourse borrowing arrangements, including apartments with car parks, office buildings and farmland.

(C) The SMSF Academy 2012
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