A recent determination by the ATO highlights some important issues for SMSFs with LRBAs.
The ATO’s determination Self Managed Superannuation Funds (Limited Recourse Borrowing Arrangements - In-house Asset Exclusion) Determination 2014 (SPR 2014/1) was registered on 10 April 2014. It treats an asset of an SMSF held under a limited recourse borrowing arrangement (LRBA) as not being an in-house asset of the fund where the fund is unable to continually meet the relevant technical requirements in certain circumstances. The determination is backdated so that its commencement coincides with the introduction of the LRBA rules from 24 September 2007.
The anomaly identified in the determination relates to an LRBA entered into by an SMSF in two situations. The first is from the time the LRBA commences until the borrowing is in place and the second is between the time that the borrowing or borrowings are extinguished and the sale of the asset or its transfer to the SMSF occurs.
In these situations, and because the SMSF is not technically complying with the in-house asset exception for LRBAs, the investment by the fund in the holding trust is treated as an in-house asset where the trustee of the holding trust is a related party for purposes of Part 8 of the SIS Act. The term ‘related party’ includes a member or trustee of the fund, a relative of a member or trustee, or a company or trust which is controlled by any of those parties, either individually or as a group.
In the first situation, which occurs at the time the LRBA is to be put in place, the contract for purchase is usually executed prior to the fund meeting all of the LRBA requirements. For example, it is unusual that a fund would have borrowed the required amount and be able to have access to it at the same time as signing the contract for purchase. In most real estate transactions, the time of settlement is usually when the borrowing is funded.
In the case of the disposal or transfer of the asset the reverse usually applies. At this time, the borrowing or borrowings are usually extinguished at or prior to the disposal or transfer of the asset. This means technically that the requirements to comply with the in-house asset rules are not met at all times because there would be no borrowing or borrowings in place. In situations where there are multiple borrowings as part of the LRBA the determination applies once the last of the borrowings has been repaid.
It is important to note that this is not a carte blanche invitation to delay the settlement of the purchase of an asset under an LRBA nor does it provide an indefinite period to hold the asset in the holding trust once the borrowings have been extinguished. The ATO cautions that SMSF trustees should take all reasonable steps to ensure there are no unreasonable delays to the commencement of the borrowing or the acquisition of the asset by the trustee of the holding trust. They also say that the modified rules will be reviewed periodically to ensure they are not being exploited.
Jordan George, senior manager, technical and policy, SPAA
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