In the 2017 Federal Budget, the Government reiterated its intention to include the use of Limited Recourse Borrowing Arrangements (LRBAs) when determining a member’s Total Superannuation Balance (TSB) and Transfer Balance Cap (TBC). However, before getting into the detail of the measure, it is important to note that the proposed change only applies to:
- LRBAs entered into from the beginning of the first quarter after the amending legislation receives Royal Assent (no set date, but it is expected to be a 1 July 2017 commencement is being targeted); and
- Where the LRBA is undertaken by a self-managed super fund (SMSF)or a small APRA fund.
The Government is concerned that without this amendment, members could use LRBAs to circumvent contribution caps and effectively transfer accumulation growth to retirement phase that is not captured by the transfer balance cap.
Just prior to the Federal Budget, the Government consulted on these amendment to the super reforms, so the announcement in the 2017 Budget was not a surprise. While the draft legislation provided as part of that process is only for consultation purposes, it is indicative of the form the measure will take if implemented by the Government.
Inclusion of LRBAs in Total Superannuation Balance
The draft legislation introduces a new concept of an LRBA amount which only applies to SMSFs and small APRA funds. Where the fund has an outstanding borrowing and the asset secured against that borrowing is, at least partially, supporting a member’s interest in the fund, the proportion of the LRBA attributable to that member is equivalent to their proportion of all the benefits supported by that asset.
Where the fund is using the proportionate (unsegregated) method, the proportion of the LRBA attributable to the member will be equivalent to their proportion of all the benefits within the fund. The following example illustrates this impact.
Don and Marie are the only members of their SMSF. The value of Don’s superannuation interests in the fund is $1 million. The value of Marie’s superannuation interests are $2 million. Together their $3 million is held in cash.
The SMSF acquires a $2 million property using $1 million cash and borrows the additional $1 million using an LRBA. The fund now has a property worth $2 million and remaining cash of $2 million.
Don’s member benefits remain at $1 million of the $3 million total (net) member benefits. As his interests are one-third of the total interests in the fund, he will need to add one-third of the value of the LRBA ($333,333) to his member benefits to determine his total superannuation balance ($1,333,333).
If Don’s benefits were in pension phase, his personal transfer balance amount would remain at $1 million. The LRBA amount does not affect the calculation for the Transfer Balance Cap
To illustrate a greater impact, if in the example above, Don and Marie both had member balances of $1.5 million (ie 50% each). The LRBA amount attributable to each of them would actually be $500,000 (ie 50% each of the $1 million LRBA). As a result of this, they would each now be deemed to have a total superannuation balance of $2 million. This change is significant as without the inclusion of the LRBA amount, both Don and Marie would have been eligible to still make a non-concessional contribution of $100,000 each. With the inclusion of the LRBA amount, they are now both ineligible to make this contribution,
Transfer balance credits for certain LRBA repayments
The second measure outlined in the consultation paper was to create a transfer balance credit where an LRBA repayment is made from an accumulation interest for the benefit of a retirement interest. Not all repayments will result in a credit as where the repayment is made from the cash flow of the asset acquired with the borrowing, there will not be any advantage to the retirement interest. In other words, those repayments do not result in an increase in the value of the retirement interest.
To illustrate the impact of this proposed change, consider the following example:
Jane is 65, the only member of her SMSF and she has benefits of $3 million which are held in cash.
After 1 July 2017, Jane’s SMSF acquires a $2 million property using $500,000 cash and borrows the remaining $1.5 million.
After the acquisition, she commences an account-based pension with $500,000 of her benefits. She segregates the fund (for asset allocation purposes) and the property and loan are segregated to supporting the pension. She receives a transfer balance credit of $500,000.
The monthly repayments on the loan are $10,000, half of which comes from the rental income. The remainder is paid from the cash supporting the accumulation interest. As each repayment funded from accumulation has the effect of increasing the value of the retirement interest, she receives a transfer balance credit of $5,000 each month.
The first point to note is that that these measures are just proposals at this stage and it is important not to make changes based on what could be significantly different from what is implemented, if it at all. Also, the changes only relate to new borrowings from 1 July 2017, so existing arrangements are not impacted. This is important as it means the correct planning and advice can be given in advance of the relevant loan.
The total superannuation balance is used for determining whether an individual can make non-concessional contributions or not, however the date the balance is tested against the $1.6 million threshold is on 30 June of the previous year. As such, if you are putting in place an LRBA which will bring the total superannuation balance for that member over $1.6 million, you can still make non-concessional contributions to super during the year the LRBA is put in place, subject to the other caps.
This is particularly important where there is an in-specie transfer of business real property and the members are claiming the small business concessions. In these cases, you may wish to make non-concessional, concessional and CGT cap contributions at various times around the time of the acquisition.
As long as the contributions are made in the same year, the inclusion of the LRBA amount in the total superannuation balance will not hinder the ability to make non-concessional contributions.
However, from 1 July of the following year the member’s ability to get extra funds into super will be restricted and therefore, it is more important than ever to ensure that the fund can remain liquid in the event of a variety of contingencies.
The second measure ensures the integrity of the transfer balance cap system. While the outcome for Jane in the example above is explainable, it is likely that she, or her fund administrator, would have to report back to the ATO each month that there has been a transfer balance credit.
It would be possible to negate the impact of these provisions by ensuring that the repayments are made only from the income from the assets acquired with the borrowing and other cash relating to the retirement interest, but it will aid administrative complexity.
This article is brought to you by BT Financial Group, and written by Bryan Ashenden, Head of Financial Literacy and Advocacy at BT Financial Group.