Changes that took effect on 7 July 2010 for limited recourse borrowing arrangements don’t seem to have dampened the enthusiasm for people being attracted to the use of this strategy to acquire either residential or commercial property within a SMSF.
These changes have however introduced a more restrictive environment in holding property, in particular for those who wish to acquire with a view to making improvements to increase the future value of the property. There are some concerns within the industry that a lack of understanding of these super laws may result in breaches of the requirements contained in section 67A & 67B of the SIS Act (click to read SPAA’s media release).
A key change to the borrowing rules is the inability to renovate or make improvements to an asset as this would fundamentally change the nature of the asset used as security by the lender. This potentially increases the risk to the fund. However, money under a limited recourse borrowing arrangement applied for the acquisition of an asset can be used for expenses incurred in maintaining or repairing the asset, to ensure that its functional value is not diminished.
Drawing down on an existing borrowing
There now appears to be some inconsistencies between the ability to undertake repairs (initial or ongoing) of an asset purchased using a limited recourse borrowing arrangement and SMSFR 2009/2, which looks at the meaning of borrow money’ or ‘maintain an existing borrowing of money’ for the purposes of section 67 of the SIS Act. This ruling treats each draw down as a separate and new borrowing. This is confirmed in paragraph 93 of this ruling where:
93. The Commissioner also considers that each drawdown of funds from a loan facility or similar arrangement constitutes a separate borrowing, even if the facility or arrangement makes provision for redraws arising from earlier repayments.
Whilst the ATO agrees that it follows that each borrowing under a LRBA must meet the requirements of paragraphs 67A(1) (a) to (f), their view is to consider the arrangement as a whole, rather than each separate borrowing under that one arrangement.
For the purposes of satisfying section 67A(1)(a), it is sufficient if the borrowed money is used to repair the acquirable asset, whether the money is borrowed initially or later into the arrangement. By taking the ‘whole view’ approach to the acquirable asset, the ATO does not regard a repair, or any materials or services used as an incident of that repair, to be an acquirable asset in their own right.
When looking at the acquisition of an acquirable asset such as property, the purchase price of an asset may be dictated by the current state of the property and its level of functionality.
The topic of initial repairs for tax purposes is contained within Tax Ruling TR97/23. It outlines many of the issues in differentiating between capital and revenue expense for tax purposes. But when considering the requirements of superannuation law (SIS Act), the timing of the deterioration is somewhat irrelevant in determining whether a borrowing can occur to rectify that deterioration (in accordance with s.67A).
It appears the issue is whether the activity is a repair according to ordinary concepts as compared to an improvement. The discussion in TR97/23 is relevant, in particular paragraphs 83 to 87 when considering the ordinary meaning of ‘repair’.
The debate of what is repair and improvement has been around for a very long time with tax professionals. It has been a “grey area” for a long time, and the introduction of this concept into limited recourse borrowing certainly adds a further layer of complexity.
To appreciate the level of interest and the ongoing questions and issues surrounding limited recourse borrowing arrangements, the last NTLG Super Technical Sub-Committee meeting conducted by the ATO recommended a workshop with member representatives of the professional bodies to work through these ever-increasing issues.
Therefore, expect to see a lot more information coming from ATO in 2011.
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