Limited Recourse Borrowing to again become a financial product

As we move closer to the implementation of industry reforms regarding the provision of financial advice, Treasury last week has added to the pile with the re-issuing of draft Corporations Amendment Regulations to provide that limited recourse borrowing arrangements as allowed under superannuation law are financial products.

These reforms were previously announced back in March 2010, with industry consultation in June of that year.  In light of the submissions previously made, Treasury has substantially revised these draft Regulations.  However, it remains a clear policy objective of Government to move these type of borrowing arrangements into the financial consumer protection framework as there continues to be concerns of targeted activity and inappropriate advice to acquire property using borrowings.

Under these Corporations Act 2001, those providing advice in respect to the limited recourse borrowing arrangement established in accordance with s67A and s67B will be required to have an Australian Financial Services License (AFSL).  For those simply providing credit facilities, they are not caught by these regulations.

To be able to provide advice in this area, an AFSL that allows for advice on derivatives or securities meets the requirements to also cover limited recourse borrowing arrangements.  This poses an interesting question for many accountants considering their licensing options with the proposed ‘conditional license’ to be implemented to allow for advice likely to be under a ‘class-of-product’.  All of the current limited licence solutions won’t provide for them to deal in securities unless they met additional competency requirements of the AFSL holder (and paid the additional licensing cost as well).

Who issues the financial product?

A previous confusion of the regulations related to the issuer of the limited recourse borrowing arrangement.  As a borrowing arrangement involves numerous parties, it is difficult to determine which party is the “issuer”, or when the product is “issued”.  These concerns posed difficulties for Government and the industry in determining which party, if any, is obliged to disclose information required under the corporations legislation.

These changes now clarify that the limited recourse borrowing arrangement is “issued” when a person enters into a legal relationship that sets up the arrangement and that each party to the arrangement is an “issuer” of the product.  It is unclear from these regulations whether related party lenders get caught under these arrangements as an issuer of a financial product?

When do these changes commence?

These proposed regulations would take effect three months after the legislative instrument was exercised by Government.

As we close in on the two-year review period proposed by the Cooper Review with limited recourse borrowings, in my view the Government can only start the clock ticking once these laws take effect.  With:

  • changes to the definition of limited recourse borrowing arrangements from 7 July 2010,
  • details of the final ruling SMSFR 2011/D1 expected in May 2012, and
  • changes to make these arrangements financial products

surely the Government’s assessment to date would be baseless? or maybe… just maybe once resolved, consumers and advisers alike will have a framework in which to work with moving forward!!  Let’s hope so.

Read the details of the Treasury Exposure draft.

How does a SMSF limited recourse borrowing arrangement work?

This short video explains how a SMSF limited recourse borrowing arrangement works in accordance with section 67A of the Superannuation Industry (Supervision) Act 1993.

This is the first of many short videos that I will start producing on various SMSF topics and strategies can be used.

Let me know what you think by rating the post!!

Will SMSF Limited Recourse Borrowing make it DIY Super again with property improvements?

With the “green light” to SMSFs being able to utilise its own cash to undertake improvements to a property acquired using a limited recourse borrowing, I think we will start to see the emergence of trustees looking to carry out renovations themselves to build their retirement savings.

Funding any improvements could be undertaken in a variety of ways:

  • Using cash reserves within the fund;
  • Using non-super cash reserves (personal funds);
  • Having a related-party tenant undertake improvements;
  • Having a non-related tenant undertake improvements; and
  • Using insurance proceeds

It is important to remember that in order to comply with section 67A(1)(a)(i), the SMSF cannot used borrowed funds to improve the acquired asset (i.e. borrowed funds can only be used for expenses incurred in connection with the borrowing or acquisition, or in maintaining or repairing the acquired asset).

With trustees having the ability to ‘get their hands dirty’ to improve property held within their SMSF, there are a few important and over-arching superannuation law requirements that must also be considered.  These include:

  • Improvements to a property made by a related party (or external party) may be classified as a contribution (refer TR 2010/1, para 11);  and
  • Work carried out by a related party on the property may breach the acquisition from related party requirements within section 66 of the SIS Act (refer SMSFR 2010/1, paras 17, 18 & 19, examples 5 and 6).
In order to avoid any breach of SIS regarding related party transactions, it is important that the SMSF is the purchaser of any goods and materials required to construct the premises directly from the supplier.  If these goods and materials that are not insignificant in value of function and are acquired by the individual(s) (maybe to get a trade discount), then the acquisition of the materials by the SMSF from the member is a breach of section 66 of the SIS.
Where improvements may be made by a tenant where a ‘make-good’ provision is in place, any improvements may not be treated as a contribution.  I say ‘may not’, simply because it would be interesting to see with a related party tenant whether all the tenant related improvements would actually be pulled down before they moved out or sold the building.  The sceptic says in me ‘unlikely’, and therefore if they don’t ‘make good’ this amount is likely to be treated as a contribution.  The interesting question is in what year would the ATO assess this as a contribution – the year in which the tenant decides not to restore the building back to its original condition, or the year in which the improvements were made? It may be argued that by not ‘making good’ on the property, the improvements were a ‘sham arrangement’ to circumvent any super law requirements, including the contribution caps.

Therefore, it is critical that any trustees looking to do-it-themselves using their self managed super fund have any understanding of the “do’s and don’ts” before they get underway.  The last thing you want is to see the capital growth achieved in the property improvement being sent to the Tax Office as a tax bill for making the fund non-complying.

The question must be asked though… does this mean that SMSFs have become true DIY (Super) again?

Find out more about these issues and the important changes from the latest SMSF ATO draft ruling at the SMSF Academy, Limited Recourse Borrowing webinar on Wednesday, 26 October 2011 at 12pm AEDST.

Last chance to register for SMSF Limited Recourse Borrowing Webinar

I am pleased to advise that the next SMSF InPractice Webinar will be on the hot topic of Limited Recourse Borrowing Arrangements.

With the recent release of the much publicised draft SMSF Ruling, SMSFR 2011/D1, this webinar is not to be missed as we explore the impact of the Commissioner’s changing views surrounding some of the key concepts with Limited Recourse Borrowing Arrangements.

Find out more details about this webinar and how to register.

SMSF Property Investing Masterclass

The ability to purchase property within a Self Managed Super Fund continues to be a key attraction for many people looking to bricks and mortar to help build their retirement savings.  Recent preliminary views expressed by the Commissioner of Limited recourse borrowing arrangements has only further sparked interest in the area of SMSF property investing.

Aaron will be presenting at the Institute of Public Accountant’s (IPA) SMSF Property Masterclass.  Join myself and a range of leading SMSF industry experts as we explore strategies, legal, tax and auditing issues around SMSF property investing, including the recently released SMSF draft ruling, SMSFR 2011/D1.

View the event details on the IPA website.

Download the event brochure.

(C) The SMSF Academy 2012
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