Limited recourse borrowing arrangements by self-managed super funds - questions and answers

Arrangements entered into on or after 7 July 2010

An SMSF is not prohibited from borrowing money, or maintaining a borrowing of money, providing the arrangement entered into satisfies each of the following conditions:

• the borrowed monies are used to acquire a single asset, or a collection of identical assets that have the same market value (that are together treated as a single asset), which the fund is not otherwise prohibited from acquiring (called the 'acquirable asset'). The new law makes it explicit that borrowed money applied to expenses incurred in connection with the borrowing or acquisition (such as loan establishment costs or stamp duty), or expenses incurred in maintaining or repairing the acquirable asset, is allowed
• the borrowed monies are not applied to improving an acquirable asset
• the acquirable asset is held on trust (the holding trust) so that the SMSF trustee receives a beneficial interest in the asset
• the SMSF trustee has the right to acquire legal ownership of the acquirable asset by making one or more payments after acquiring the beneficial interest
• any recourse that the lender or any other person has under the arrangement against the SMSF trustee is limited to rights relating to the acquirable asset. This limitation applies to rights directly or indirectly relating to a default on the borrowing and related charges or directly or indirectly relating to the SMSF trustee's rights in respect of the acquirable asset (for example, rights to income from the asset)
• the acquirable asset is not subject to a charge other than as provided in relation to the borrowing by the SMSF trustee
• the acquirable asset can be replaced by another acquirable asset that the SMSF is not otherwise prohibited from acquiring, but only in very limited circumstances as listed in the super law.

These rules are in section 67A and section 67B of the SISA.

Special in-house asset rule

The holding trust in most limited recourse borrowing arrangements is, under the super law, a related trust to the SMSF investor, because the SMSF has an entitlement to the majority of the income from the trust. The interest of the SMSF in the holding trust represents an investment in that trust for the purposes of the in-house asset rules. However, the in-house asset rules have an exception (specifically in subsections 71(8) and 71(9) of the SISA) to ensure that the SMSF's investment in the holding trust is not an in-house asset, provided all these conditions are satisfied:

• the holding trust is part of an arrangement that meets all of the requirements of the super law in connection with a borrowing by the SMSF
• the only property of the trust under the arrangement is the acquirable asset (referred to as the original asset or its replacement under the pre-amendment law)
• the asset held by the holding trust would not be an in-house asset of the SMSF if the SMSF owned the asset directly.

For more guidance on in house assets, refer to self-managed super funds ruling SMSFR 2009/4 Self-Managed Superannuation Funds: the meaning of 'asset', 'loan', 'investment in', 'lease' and 'lease arrangement' in the definition of an 'in-house asset' in the Superannuation Industry (Supervision) Act 1993.

When can an acquirable asset be replaced in an arrangement that commenced on or after 7 July 2010?

The circumstances when an acquirable asset in a limited recourse borrowing arrangement can be replaced are listed in section 67B of the SISA.

Regulations can be made to allow for replacement in additional circumstances, but as at 26 July 2010 no regulations have been made for this purpose. The circumstances listed in section 67B are:

1. A share in a company (or collection of such shares) can be replaced by a share (or collection of such shares) in the same company if, at the time of replacement, the original asset and replacement have the same market value (for example, if there is a share split). (Subsection 67B(3)).
2. A unit in a unit trust (or collection of such units) can be replaced by a unit (or collection of such units) in the same unit trust if, at the time of replacement, the original asset and replacement have the same market value. (Subsection 67B(3)).
3. If the original asset is an instalment receipt that converts to a share or collection of shares in a company, then that share (or collection of shares) is allowable as a replacement asset. (Subsection 67B(4)). For these purposes an 'instalment receipt' is defined to mean an investment under which a listed security is held in a trust until the purchase price of the security is fully paid and the security, and property derived from the security, is the only property of that trust. (Subsection 10(1)).
4. A share in a company (or collection of such shares) can be replaced by a share (or a collection of such shares) in another company if the replacement occurs because of a takeover, merger, demerger or restructure of the first company. (Subsection 67B(5)).
5. A unit in a unit trust (or collection of such units) can be replaced by a unit (or collection of units) in another unit trust if the replacement occurs because of a takeover, merger, demerger or restructure of the first trust. (Subsection 67B(5)).
6. A share in a company (or collection of such shares) can be replaced by a stapled security (or collection of such securities) if the replacement occurs under a scheme of arrangement of the company - for example, as part of a restructure. The stapled security must consist of a share (or a single collection of shares of the same class) stapled together with a unit (or a single collection of units of the same class) in a unit trust. (Subsection 67B(6)).
7. A unit in a unit trust (or collection of such units) can be replaced by a unit (or collection of units) in that trust if the replacement occurs as a result of an exercise of a discretion granted to the trustee of that unit trust under the trust deed (for example, a managed investment scheme trustee exercises a discretion to split or consolidate units). (Subsection 67B(7)).

What are the consequences if the limited recourse borrowing arrangement does not satisfy all of the required conditions?

If the required conditions are not strictly satisfied, borrowing money under the arrangement will result in a contravention of one or more of the super laws. Such a contravention may have civil or criminal consequences.

Sections within Requirements under the super law for limited recourse borrowing by super trustees

• Arrangements entered into on or after 24 September 2007 and before 7 July 2010
• Arrangements entered into on or after 7 July 2010