Notice:
The information below is up to date as of the 11/3/16 and is general in nature only.
Please do not make decisions on your SMSF without obtaining personalised financial advice.
Self-Managed Super Fund Lending
“Self-managed super fund lending is a little more complex in terms of paperwork and the individuals involved. We can help you with accountants and lawyers as far as setting a structure up. It needs to be absolutely correct so it does not fall fail of any of the laws involved with self-managed super fund lending. The pool of lenders available for self-managed super fund lending tends to be much smaller because of the rules and regulations involved. The lending also tends to be limited to somewhere between 70 to 80 percent lend against the value of the property. Any loan granted will be on a limited recourse basis. This allows the lender to take security over the investment property in the self-managed super fund but It will not allow the lender to chase any of the other assets in the self-managed super fund should it go wrong. Because of this the lender may ask for a personal guarantee. Because of the complexities involved with setting up the structure you will have to seek legal and accountants advice so the structure is set up correctly from the outset. The information on our website is general and nature only and should only be used as a guide.
Limited recourse borrowing arrangements
Where an Self Managed Super Fund has borrowed to acquire an asset under a limited recourse borrowing arrangement, the trust required to hold the asset on behalf of the fund will not be an in house asset of the fund where:
• the only property of the trust is the single acquirable asset acquired with the borrowing (or an allowable replacement asset).
• the asset held on trust for the SMSF would not be an in house asset of the SMSF if it were held directly by the SMSF.
For example, if a trustee acquired a residential investment property under a Limited Recourse Borrowing Arrangement (LRBA), and the property was then leased to an unrelated party, the holding trust would be exempt from the in-house asset rules. However, if the property was instead leased back to a related party, such as a member of the fund, the exemption would not apply as the property would be an in house asset if it were held directly by the fund. It is also important to note that under the in-house asset exemption, the trust is strictly only exempt from being an in-house asset during the period that the loan is in place. Therefore, where the trust was established prior to the loan being established, for example where a deposit has been paid to acquire an asset, the trust would strictly be an in-house asset of the fund. The same situation would also occur where the asset was maintained in the trust arrangement once the loan had been repaid. To address this situation, the ATO registered a legislative instrument 24 on 4 April 2014 confirming that the holding trust established under an LRBA will not be an in house asset of a fund where:
• the loan under an LRBA has not yet begun, and
• the related trust does not yet hold the asset to be acquired under the LRBA and that it is reasonable to conclude that: –
• the borrowing will occur –
• the related trust will hold the asset to be acquired under the LRBA –
• the asset acquired under the LRBA would not cause the holding trust to be an in-house asset of the fund when the holding trust begins to hold the asset.
In addition, the instrument also confirms that the holding trust will not be treated as an in-house asset once the loan is repaid where:
• the in-house asset exemption for LRBA arrangements resulted in the holding trust not being an in-house asset of the fund from the time when the related trust began to hold the asset acquired under the LRBA until when the borrowing was repaid; and
• the in-house asset exemption for LRBA arrangements would result in the holding trust not being an in-house asset of the fund but for the fact that borrowing had been repaid.
For example, where an SMSF acquired a residential investment property under an LRBA, there would be no requirement to transfer the legal title of property back to the SMSF after the loan has been repaid as the in-house asset exemption will continue to apply (so long as the property wouldn’t itself have been an in-house asset if it was held directly by the fund).
This is important as it could allow a trustee to maintain the asset in the trust so as to avoid any risk of stamp duty applying to the transfer of the property from the trust to the SMSF once the loan has been repaid.
Separate trust arrangement
Under the limited recourse borrowing rules, the asset acquired with the borrowing must be held on trust so that the trustee of the SMSF acquires a beneficial interest in the asset. This means that the SMSF trustee will not be permitted to hold the legal title of the asset and that a separate custodian or holding trustee must hold the legal title of the asset under a separate trust arrangement for the benefit of the SMSF.
Depending on whether an SMSF has a corporate trustee, the members of an SMSF may act as the holding trustee and hold the asset for the benefit of their fund. However, in many situations a lender will require a separate company be established for the specific purpose of acting as the holding trustee with the members being appointed as directors. This ensures compliance with the requirement of a clear separation of ownership between the trustee of the SMSF and the custodian holding the asset.
Permitted use of borrowings
Under the LRBA provisions, a trustee is permitted to use borrowings to acquire a single acquirable asset as well as to pay for borrowing and transaction costs and to fund any repairs and maintenance to the asset acquired with the borrowings. However, the provisions specifically prohibit the borrowings from being used to improve the asset.
The distinction between what is maintenance/repairs and what is an improvement is therefore extremely important where borrowings will be used to fund work on a property. In SMSFR 2012/1, the ATO provides guidance as to the meaning of these terms in relation to a limited recourse borrowing arrangement.
Meaning of maintenance
The ruling clarifies that maintenance in the context of the borrowing rules includes work done to prevent defects in, damage to, or deterioration of an asset and contemplates the continued existence of the asset.
For example, maintenance would generally include the repainting of walls, the treatment of a property to prevent termite attack and the installation of mains connected smoke alarms.
Meaning of repair
The ruling defines a repair for the purpose of the borrowing rules to include work to remedy or make good defects in, damage to, or deterioration of an asset and contemplates the continued existence of the asset. The ruling further clarifies that a repair is usually occasional and partial and involves replacing a part of something that is already there that has become worn out, dilapidated or damaged. However, the ruling also confirms that a repair would not involve anything that replaced the asset entirely or that changed the character of the asset.
For example, a repair would generally include the replacement of rusted guttering or a roof that was badly damaged in a storm. Repairs would also involve work done to replace part of the timber frame of a house that has been attacked by termites.
In SMSFR 2012/1, the ATO confirms that where a trustee wishes to drawdown on an existing loan to fund repairs, the drawdown will only be permitted where the drawdowns are provided for under the terms of the limited recourse borrowing arrangement. Therefore, before drawing down on a loan to fund any maintenance or repairs, the trustees should check to ensure that additional drawdowns are provided for under the terms of their specific limited recourse loan arrangement.
Meaning of improvement
In contrast, the ruling outlines that an asset is improved if the state or function of the asset is significantly altered for the better, through substantial alterations, or the addition of further substantial features or rights to the asset.
In the ruling, the ATO confirms that whether work constitutes a repair or an improvement is a question of fact and degree that takes into account the appearance, form, state and condition of the asset as at the time of acquisition. However, the ATO does confirm that it is possible to use borrowings to repair the asset acquired with the borrowings even where the damage occurred and was known about prior to the trustee acquiring the asset. However, it also points out that the greater the state of deterioration the more likely the subsequent alterations or changes will be considered improvements.
Minor and trifling improvements
In the ruling, the ATO confirms that alterations to the acquirable asset will not amount to an improvement if the state or function of the acquirable asset is only bettered to a minor or trifling extent as compared to the asset as a whole.
Other monies used to fund improvements
Although borrowed monies cannot generally be used to improve an asset, the ATO has confirmed that money from other sources (ie non‑borrowed monies) can be used to improve the asset. However, this will only be possible where the scale and nature of the improvements do not fundamentally change the character of the asset and therefore effectively create a non‑allowable replacement asset.
For example, in SMSFR 2012/1, the ATO confirms that an SMSF trustee may be able to use the fund’s own cash reserves to renovate a residential property to add bedrooms and a swimming pool as these changes would not fundamentally change the residential character of the asset. Conversely, the ruling also confirms that subdividing a property or converting a residential property into a commercial property would fundamentally change the character of the asset and create a non‑allowable replacement asset.
Other related expenses and refinancing
The rules also allow the borrowing to be used to cover any expenses incurred in connection with the borrowing or acquisition of the acquirable asset. For example, a borrowing could be used to fund the following expenses:
• legal costs, such as conveyance fees and charges
• state government stamp duty
• lender fees and charges, such as loan establishment costs.
Income and capital gains tax
The Federal Government has confirmed that a superannuation trustee who enters into a limited recourse borrowing arrangement for the purpose of purchasing an asset is to be treated as the owner of the asset for income tax purposes. This generally means that any income generated by the asset must be included in the fund’s assessable income and that there will be no capital gains tax event when the asset is transferred back to the SMSF after the loan has been repaid.
Trustees that have borrowed for investment purposes will also generally be entitled to claim the cost of any interest expenses incurred in gaining or producing assessable income as a tax deduction under basic concepts.
Stamp duty
The SMSF trustee will generally be liable for stamp duty on any asset acquired via a limited recourse borrowing arrangement. However, a range of concessions is generally available to avoid stamp duty applying a second time on the declaration of trust over the asset and when the asset is transferred to the SMSF after the loan is repaid. Unfortunately, these rules can be complex and vary depending on which state the property is located. Specialist legal advice should therefore be sought to ensure the borrowing arrangement is structured to comply with the requirements of the relevant state concession.
Common mistakes
• Properties purchased with or on multiple titles may need a separate trust for each property or title e.g. inner city apartments with a unit and car park on separate titles may required a bare trust for each title if they can be sold independently.
• Properties purchased using an LRBA cannot be significantly changed e.g. major renovations etc.
• Borrowings improve / change an existing property held within the super fund. Trustees sometimes do not understand that any borrowing must be utilised only to acquire a new single asset.
• Believe incorrectly that super funds can borrow using the same strategies when borrowing personally or within a family trust structure (e.g. using existing unencumbered properties as security).
• Often sign a contract to purchase then seek advice.
• Execute the contract in the wrong name. As some states do not allow ‘and / or nominee’ clauses, this has the potential for additional stamp duty.
• Do not understand that the super fund must have cash to pay its share of the purchase price i.e. deposit.
• Want to borrow with little or no deposit.
• Do not understand that negative gearing does not work in a low tax (i.e. superannuation) environment.
• Forget that as trustees, investments are for the benefit of the members (not for the convenience of their business).
Penalties
Self Managed Super funds including borrowing can be complex. And the penalties for getting it wrong can be harsh. Where a trustee fails to maintain their fund in accordance with the legal requirements, the ATO can impose a number of penalties. These include:
• ATO administrative penalties
• taking legal action against trustees, in which case a court can impose penalties of up to $340,000 per individual trustee or $1.7 million for funds with a corporate trustee and/or five year’s imprisonment
• disqualifying the trustees
• revoking the fund’s complying tax status – which will result in both the fund’s income and taxable benefits being taxed at the top marginal tax rate.
Trustees should also note that where a penalty is applied they will generally be personally liable and they will not be able to be indemnified out of the assets of the fund.