The ATO’s view on borrowing in Self Managed Superannuation Funds (SMSFs)
October 12th, 2011 | Accounting News, Consumer News, Financial Planning News, Legal News, Tax Advice and Updates
The ATO’s view on Limited Recourse Borrowing Arrangements (LRBA) within Self Managed Superannuation Funds (SMSF’s) has been clarified with the release of the Draft Self Managed Superannuation Funds Ruling (SMSFR 2011/D1) on 14 September 2011.
Money borrowed under a Limited Recourse Borrowing Arrangement (LRBA) can be used for repairs and maintenance of the asset but not to improve the asset. Repairs and maintenance can be at the time of purchase or at a later stage. If the money borrowed improves the property, then the borrowing exception in Section 67A ceases to apply and the Fund is in breach of Section 67.
There has been confusion in this area, as ‘maintaining’, ‘repairing’ and ‘improving’ are all common terms and not defined in the legislation. The ATO notes the following:
- Maintaining generally means work done to prevent defects, damage or deterioration of an asset, or in anticipation of future defects, damage or deterioration – provided that it merely ensures the functional efficiency of the asset is maintained in its present state.
- Repairing generally means remedying or making good defects in, damage to, or deterioration of, an asset and contemplates the continued existence of the asset. Therefore, repairing something restores its functional efficiency. The ATO goes on to state that “an asset may be acquired in a state in which a part of the asset is defective, damaged or suffering some deterioration of what would be considered to be its normal level of functional efficiency. Restoration of that part of the asset to its functional efficiency would be a repair for Limited Recourse Borrowing Arrangement purposes.”
- The ruling seems to suggest that the repair needs to bring the item back to its original condition, but not go beyond that. The cost of the works in the context of the overall asset, is also likely to be a factor in the ATOs assessment of whether or not what has occurred is deemed a repair, maintenance or an improvement.
- Defining improvement remains a grey area, as it is a matter of fact and degree whether something is merely maintained, repaired or has been improved. The ATO states that “minor or trifling increases in functional efficiency or value as compared with the acquirable asset as a whole will not amount to an improvement.”
The Draft Ruling provides a number of examples relating to repairs and improvements of assets using borrowings.
Applying the Draft Ruling, the following are likely to be deemed repairs:
- Replacing a damaged kitchen with a new kitchen
- Replacing roofing with new roofing
- Painting the exterior of a house
- Resurfacing a swimming pool
Applying the Draft Ruling, the following are likely to be deemed improvements and thereby transform the existing asset into a different asset:
- Adding a second storey to a single storey residence
- Adding a swimming pool
- Adding one or more rooms
A trustee can use money from other sources to improve a property acquired under a Limited Recourse Borrowing Arrangement, as long as these improvements do not result in the asset becoming a different asset. For example, if the fund acquires a vacant block of land under a Limited Recourse Borrowing Arrangement, it cannot then subdivide the land as the asset has been fundamentally changed into several different assets.
Off the Plan Purchases
The draft ruling provides that a SMSF Trustee can enter into an off the plan purchase and use borrowed monies to complete the purchase.
Typically, in an off the plan purchase arrangement, a Contract for Sale is entered into and a deposit is paid at the time of signing the contract. The contract is an agreement to purchase an asset (e.g. a strata unit) not yet in existence. If and when the strata property is constructed and the relevant registrations completed, the purchaser must then provide the balance of the purchase monies.
The Draft Ruling provides that so long as the trustee finances the deposit from its own resources, the trustee could enter into a limited recourse borrowing arrangement for the balance of the purchase price.
As you can see, the stance on using the SMSF’s own available resources to improve the asset has somewhat changed. This may now be achieved, so long as the improved asset is not seen to be a new asset.
It is never too early to start thinking about how to maximise your income in retirement. Here at The Quinn Group our experienced team of Financial Planners, Accountants and Lawyers can provide you with the total solution and assist you with all your SMSF needs. For advice about whether borrowing in your SMSF is right for you to get the best chance at the lifestyle you want, contact Peter Quinn by submitting an online enquiry or calling us on +61 2 9580 9166 to book an obligation free appointment.
The information in this document does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it. It is important that your personal circumstances are taken into account before making any financial decision and it is recommended that you seek assistance from your financial adviser.