There has been a lot of discussion in the media as to whether the government is intending to remove the borrowing provision referred to as “limited recourse borrowing arrangements” (LRBA) from the superannuation law.  Removing the provision was one of the recommendations made by the Financial Systems Inquiry’s Murray Report.

I personally don’t believe our government will ban it altogether.  It has taken this long to structure the law in such a way to protect assets of a self managed superannuation fund (SMSF) where the SMSF is unable to repay the loan. 

Based on my work with SMSF clients and professionals, most understand how to structure an LRBA, organise the necessary paperwork and ensure the correct wording appears on the relevant documents associated with LRBAs. 

If the government decides to impose some restrictions on LRBAs, it may impose tighter controls which only allow financial institutions to lend money under an LRBA or only allowing commercial properties to be acquired by SMSFs under LRBAs.

What I also know from my 28 years of dealing with government issues, while working for the Australian Taxation Office, is that if a law is changed, the government will put in place “grandfathering” provisions or transitional provisions, just like it did with the in-house asset rules and the acquisition of collectables and personal use assets.

The grandfathering provisions will allow people who have already entered into LRBAs to continue to do so by complying with the requirements under the old law.

So if it is your intention for your SMSF to enter into an LRBA to acquire an asset, then you will need to consider whether to do so now in case the law is changed or abandoned.

So what is an LRBA?

A limited recourse borrowing arrangement allows an SMSF to borrow money to purchase an asset.  The asset is “quarantined”, from the SMSF’s other assets, by being held in a separate trust referred to as a bare trust.  Under the current law, anyone can lend the money to the SMSF but the terms must be under a limited recourse.  This means, if the SMSF defaults in any loan repayments the lender only has the right to take the asset that is held by the bare trust and cannot touch any of the SMSF’s other assets.

So you can see already that this borrowing provision is unlike other loan contract.  If you were to borrow money from a financial institution to acquire a property, it is usually on a full recourse basis.  If you default in loan repayments on a full recourse basis, the lender can come and take the property as well as anything else that you might list as security on the loan.

Now, when I was auditing SMSFs (while working in the ATO during 2010 and 2013), I came across many documents associated with LRBAs that were drawn up incorrectly.  People were incorrectly putting down the SMSF as the purchaser of the asset; putting down the bare trust as the borrower to the loan; members were putting down the deposit on a property from their own pockets and the trustee of the SMSF was acting as the trustee to the bare trust.  This is all incorrect.

The problem is that if the LRBA is not structured correctly, you may only be provided with two options by the ATO.  The first option is to get rid of the loan and the second is to get rid of the asset that has been acquired with the borrowings.  Both options may end up costing the SMSF a great deal of money.

What to consider in structuring an LRBA

Some of the more common issues people face (and often get wrong!) when attempting to structure their LRBA include:

• Buying Property with multiple titles;
• Buying parcels of shares;
• Who is the Trustee of the Bare Trust;
• How to make an offer;
• Providing deposits; and
• Acquiring finance through related parties

Gold and premium members, read on for details on these issues.

Law Central now has an on-line document to create a bare trust.

This article was prepared by Monica Rule who worked for the Australian Taxation Office for 28 years and is an SMSF Specialist Adviser. Monica is the author of The Self Managed Super Handbook – Superannuation Law for Self Managed Superannuation Funds in plain English - www.monicarule.com.au

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