Financial Clarity

Thursday, 6 October 2011

BORROWING THROUGH YOUR SELF-MANAGED SUPERFUND.
What’s the latest from the Tax Office?

The Australian Taxation Office (“ATO") has released Draft Tax Ruling SMSFR 2011/D1 to clarify a number of issues that may arise when Trustees of SMSFs use Limited Recourse Borrowing Arrangements (LRBA) to acquire assets.  The draft ruling reflects a relaxation of position by the ATO in regard to what constitutes the definition of a ‘single acquirable asset’.  The LRBA provisions are found in sections 67A and 67B of the Superannuation Industry (Supervision) Act 1993 (SISA). 

MGD Wealth has been closely involved in the consultative process by the superannuation industry with the ATO which, we are pleased to say, has contributed to the development of a more flexible approach to the SMSF borrowing provisions.
 

The key concepts explained in this draft ruling are:

• What is an ‘acquirable asset’ and a ‘single acquirable asset’;
• 'maintaining’ or ‘repairing’ the acquirable asset as distinguished from ‘improving’ it; and
• When a single acquirable asset is changed to such an extent that it is a different (replacement) asset.  

We emphasise that this is a draft ruling at this point that may be subject to change as the ATO is inviting comment from interested parties, due by 28 October 2011. Once the ATO finalises its position we will let you know!

Single acquirable asset
The ruling focuses mainly on real property, although it applies to all assets that can be acquired in a superannuation fund.  For example, a factory building may straddle two or more land titles and still be regarded as a single asset.  Conversely, where parts of a property can be dealt with separately, it is generally not a single asset and would fail the single acquirable asset definition.

Maintaining or repairing an asset
In the context of the LRBA provisions, there is not much difference between maintaining or repairing a property.  The former refers to preserving the condition of the asset, while the latter ordinarily means making good defects, damage or deterioration.  Money borrowed under a LRBA may be applied not only in acquiring the acquirable asset, but also in carrying out repairs and maintenance to the asset whether necessary at the time of its acquisition or at a later time.

Improvements
Although borrowings under a LRBA cannot be used to improve a single acquirable asset that is the subject of the LRBA, money from other sources could be used to improve (or repair or maintain) that asset.  However, any improvements must not result in the acquirable asset becoming a different asset. 

Unfortunately, there is still a degree of ambiguity surrounding the ATO interpretation of the rules as they may apply to improvements carried out with the fund’s cash resources.  Consideration must be given to whether any improvements or other changes to an acquirable asset result in a different (replacement) asset being held on trust under the LRBA in circumstances not covered by section 67B.

A common example is where a vacant block of land is acquired by a SMSF under the LRBA and it is proposed that a dwelling be built on the land.  The character of the asset has fundamentally changed along with the underlying proprietary rights and, consequently, this is a different asset.

Replacement
The original view of the regulator was that in the event that an asset was destroyed, then any replacement would not be covered by a LRBA as it would be seen as a new asset.  Most insurance policies insist on the replacement or reconstruction of the property in the event of a claim, rather than a cash settlement.  The new approach recognises how insurance policies usually operate.

This has been an area of concern to those wanting to enter into a SMSF borrowing arrangement, particularly after the Queensland floods.

Where to from here…
MGD Wealth will continue to contribute to the process to achieve the best outcome for our clients. 

We will also be holding some client information sessions for those who may be currently considering utilising the borrowing provisions to acquire investment property in their SMSFs.  We will contact you shortly in this regard.

In the interim, please contact your MDG Wealth adviser or Patrick Crossan of our office on (07) 3391 5055 to discuss any questions you have on this complex aspect of SMSF administration and investment.

Michael Lorimer
Director
Head of SMSF Advisory