SMSF Borrowing

SMSF submission to the Financial System Inquiry

Financial System Inquiry submission - SMSF

This submission will focus on three questions raised by the Financial System Inquiry interim report:

  • Restoring “the general prohibition on direct leverage of superannuation funds on a prospective basis”
  • “To what extent should the Inquiry be concerned about the high operating expenses of many SMSFs?”
  • “Should there be any limitations on the establishment of SMSFs?”

Leverage in superannuation funds

Given that the Financial System Inquiry (FSI) interim report notes “leverage in APRA-regulated funds is small, with total borrowings of under $2 million reported each quarter over the past year” this submission will be limited to consideration of borrowing by SMSFs.

Borrowing by SMSFs has been a growing and changing area, which has also caused concern in some sectors. This includes the Super System Review (Cooper Review) panel, which recommended that a review of SMSF borrowing be conducted within two years – which would have been by 2012:

“The 2007 relaxation of the borrowing provisions and the consumer protection measures that have recently been announced should be reviewed by government in two years’ time to ensure that borrowing has not become, and does not look like becoming, a significant focus of superannuation funds.”

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Financial System Inquiry: Brisbane Public Forum

FSI, Financial System Inquiry, Public Forum - BrisbaneThe Financial System Inquiry has been holding public forums, as part of the consultation process following the release of the interim report.

This included one in Brisbane on the 19th of August, with others held in Sydney, Melbourne and Perth.

These events are opportunities for members of the public, who aren’t part of the normal consultation process, to raise their concerns with members of the panel.

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ATOs stance on 0% LRBAs reinforced by more private rulings

ATO Private Binding Rulings - 0% LRBAs and non-arm's length incomeThe ATO has issued a number of new Private Binding Rulings with the view that 0% limited recourse borrowing arrangements by SMSFs will result in non-arm’s length income.

In April the ATO surprised some when it issued a Private Binding Ruling (PBR)  that said a 0% LRBA arrangement would result in the income earned from the asset being non-arm’s length income, and so taxed at 45%.

Since then the ATO has issued a number of further rulings with the same finding, indicating that it is a broader view held by the ATO rather than one only applicable to the individual situations of a particular case. Some of these private rulings seem to be for arrangements already in place, perhaps by SMSF trustees concerned that their strategies might not have the desired result?

Read More »ATOs stance on 0% LRBAs reinforced by more private rulings

SPAA announces SMSF LRBA lender & adviser guidelines

SPAA SMSF Limited Recourse Borrowing Arrangements (LRBAs) guidelines - advisers and lendersSPAA has released guidelines for lenders and advisers working with SMSF Limited Recourse Borrowing Arrangements (LRBAs), with NAB the first bank to sign up to use the guidelines and other major lenders in the “pipeline”.

SPAA CEO Andrea Slattery says that, with the release of the guidelines, “Government and regulators can have a high degree of confidence that LRBAs are being used appropriately and that the industry has best practice guidelines for lending and advice in place.”

SPAA LRBA Lenders Guidelines

According to SPAA the LRBA guidelines for lenders are “intended to establish banking industry standards” to work with other lending policies. The guidelines include items such as:

  • Seeking acknowledgement from the SMSF trustees that they were recommended to seek expert advice
  • SMSF trustee to certify the SMSF is complying with SIS requirements
  • Lenders to provide information to trustees, including:
    • Details of the LRBA structure
    • “Advantages/risks of LRBAs”

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SMSF real estate investment advice needs regulation

SMSF & Superannuation NewsThe Bank of Queensland, in its submission to the Senate committee investigating proposed changes to the FoFA reforms, has raised the issue of increased regulation to protect consumers, including SMSF real estate investors, from property promoters. Calling the different regulatory approaches between real estate and other investments an “anomaly” BOQ recommends that “advice on the purchase of real estate, other than for owner occupiers, be included in the definition of financial advice”. This would provide a “consistent framework” and there is no “valid reason for the financial services licensing system not to apply to advice with respect to real estate investments”. Part of this concern comes from BOQ seeing unregulated real estate investment advice driving consumers into SMSFs which are inappropriate for them, including because the “fund too small to be economic” or the “consumer is not equipped to be a trustee”.

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Will there be a review of SMSF Borrowing and LRBAs?

SMSF borrowing property - limited recourse borrowing arrangement LRBAComments by the then Assistant Treasurer Arthur Sinodinos seem to have put to an end to the long-expected review into SMSF Limited-Recourse Borrowing Arrangements (LRBAs). However there is still support for such a review in the submissions so far to the Financial System Inquiry.

The Cooper Review (Super System Review) made the following recommendation in regards to SMSF borrowing and LRBAs:

Recommendation 8.10: The 2007 relaxation of the borrowing provisions and the consumer protection measures that have recently been announced should be reviewed by government in two years’ time to ensure that borrowing has not become, and does not look like becoming, a significant focus of superannuation funds.”

As the Cooper Review was released in 2010 this would have meant a review of LRBAs by 2012. It appears from the Review Paper that the thinking behind the above recommendation was that the changes to SMSF borrowing were “still recent”. The announcement by the government of the intention to make LRBAs Financial Products under the Corporations Act seems to have also influenced the Panels thoughts on the matter. However it is now over four years since that announcement and the proposed changes have not been implemented. The Panel did seem to be concerned about SMSFs borrowing, believing it to be “inconsistent with Australia’s retirement policy” and wanted to ensure that “borrowing does not become a significant focus of SMSFs”.

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ATO exemption – LRBAs and In-House Assets

SMSF borrowing property - limited recourse borrowing arrangement LRBAThe ATO recently issued a Determination so resolve an issue where the In-House Asset rules could apply to an Limited Recourse Borrowing Arrangement (LRBA) which was otherwise complying with both the SIS Act/Regulations and ordinary practice.

The Determination, the Legislative Instrument Self Managed Superannuation Funds (Limited Recourse Borrowing Arrangements – In-house Asset Exclusion) Determination 2014 (2014/SPR/0008), is issued under s71(f) of the SIS Act, which empowers the regulator to make determinations that an asset is not an In-House Asset.

At issue is the exemption provided by s71(8) of the SIS Act. This sub-section provides an exemption from the In-House Asset rules where an SMSF has an investment in a Custodian Trust (or Holding Trust as it is referred to by the ATO) as part of an LRBA. However, as set out in the Explanatory Statement, this exemption does not cover certain circumstances:

  • Where a contract has been entered into but the borrowing has yet to commence (Paragraph 19)
  • Where a borrowing has been entered into, but the custodian trust does not yet hold the asset – such as where a deposit it made for an off-the-plan unit (Paragraph 21)

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SMSF LRBA: 0% Interest can equal 45% Tax

PercentThe ATO has recently issued a Private Binding Ruling which casts some doubt on 0% interest-rate limited-recourse borrowing arrangements (LRBAs). Should this interpretation be correct SMSFs with LRBAs at 0%, or indeed below-market rates of interest, could owe 45% tax on income relating to the LRBA Investment. Since 2010, based on a number of binding and non-binding ATO sources, there has been increasing comfort with the SIS compliance of related-party LRBAs, including at below-market rates of interest. This broader interest came as a result of minutes of the National Tax Liaison Group (NTLG) Superannuation Technical Sub-group meeting in June 2012, where the ATO said that such an arrangement could be consistent with s67A and s109:

“Yes. A lower than market interest rate or the absence of a requirement to pay interest on money loaned to the trustee by a related party will not prevent the arrangement from being a borrowing for the purposes of section 67A of the SISA”

“a fact that the borrowing is interest free does not cause a contravention of paragraph 109(1)(b) of the SISA as that fact does not make the terms and conditions of the borrowing more favorable to the related party lender than would be reasonably expected if the parties were dealing with each other at arm’s length in the same circumstances.”

Read More »SMSF LRBA: 0% Interest can equal 45% Tax