Today has seen the release of the most anticipated ATO Ruling impacting superannuation for the year, with the issuing of draft SMSF Ruling, SMSFR 2011/D1. This ruling addresses key concepts for limited recourse borrowing arrangements.
Most importantly, there are some ‘good news’ stories within this SMSF Ruling, with clarity being provided around the contentious issues of:
- what is an ‘acquirable asset’ and “single acquirable asset’;
- distinguishing between repairs and improvements; and
- what constitutes a replacement asset.
The industry since the introduction of sections 67A and 67B is SISA from 7 July 2010, has argued that the strict interpretive view taken by the Regulator defining the acquired asset by its legal boundaries was too narrow and that it needed to consider the ‘economic substance’ of the asset. Whilst not adopting this or other alternative views submitted from within the SMSF industry, the ATO’s interpretation within this ruling considers both the legal form and substance of the asset acquired. As a result, this SMSF Ruling provides some real positives for limited recourse borrowings in respect to real property, in particular around improving the asset using cash from within a SMSF.
Single Acquirable Asset
It is the ATO view within the SMSF Ruling that where an asset can be dealt with separately, this will mean it is more than one asset for the purposes of the LRBA provisions. The fact that someone wants to deal with the asset as a ‘package’ does not mean it is a single acquirable asset. An exception however would be where laws of a State or Territory prevent the assets being dealt with separately.
The following within SMSFR 2011/D1 outline what does constitute a ‘single acquirable asset’ in accordance with section 67A (in addition with what we already know around land & buildings):
- a factory or office building on more than one title;
- off-the-plan apartments where the borrowing commences upon property being completed and strata-titled;
The following however does not meet the ‘single acquirable asset’ provisions and would require multiple LRBA arrangements:
- Two or more adjacent blocks of land wanting to be sold together;
- Farmland with multiple titles;
- A house built in-situ
- Apartment with separate car park (unless titles cannot be assigned or transferred separately);
- Furnishings required to be purchased with serviced apartment
Repairs, Maintenance & Improvements
In what is a real positive for this legislation, the ATO have confirmed that money other than borrowings can be used to fund improvements (or for repairs or maintenance). This includes using cash within the SMSF to undertake the improvements. However, any improvements must not result in the acquirable asset becoming a different asset (replacement asset, s67B of SISA). Conversely, any improvements undertaken with borrowed money is no allowed and a breach of subparagraph 67A(1)(a)(i).
This change to a ‘single acquirable asset’ is a question of fact and degree of the particular circumstances. For example, a property may have been replaced entirely, altered to an extent that it now has a different purpose or function, the proprietary rights have changed, or altered in a way in which a single acquirable asset no longer exists (e.g. subdivided).
The ruling states that an asset can be acquired with a borrowing which is defective, damaged or suffering some deterioration. This provides an ability to undertake ‘initial repairs’ (or restoration); however, the greater the state of deterioration of the asset at the time of acquisition using a LRBA, the more likely the changes will be regarded as a different asset (e.g. replacing broken windows vs. renovating a ‘run-down’ house). It is therefore important to consider the asset’s qualities and characteristics at the time the SMSF entered into the LRBA.
The ATO uses various examples within the Ruling to demonstrate the difference between repairs and improvements for section 67A of SISA, along with where a change to a single acquirable asset becomes a different asset (replacement asset).
The following are allowed as improvements without resulting in a different asset:
- An addition of a new pool or new garage;
- The addition of a second story on a house, rather than simply replacing a roof;
- With farmland, additional fencing, dams, bores or tanks were installed;
- A house burnt down by fire and re-built with insurance proceeds (restored as the same asset)
These improvements must all be undertaken with monies other than borrowings used to improve the asset. Borrowings cannot be used to improve the single acquirable asset (but the fund’s own cash can).
The following however are not allowed as they would result in a different asset:
- Subdividing a vacant block of land;
- Renovating (i.e. bathroom) using borrowings;
- Developing a vacant block of land;
- Demolishing a house and building 3 x townhouses;
- Rezoning of an asset from residential to commercial (or vice versa);
- A house burnt down by fire but constructed a different type of building (e.g. two units)
For the above ‘different assets’, you still have the ability to use a SIS Regulation 13.22C related trust arrangement to undertake some of these activities. The SMSF is the contributor of the capital with cash and borrowings, with the ungeared unit trust being the purchaser & developer.
These draft views expressed by the ATO provide us with some much-needed guidance in this growing area of the self-managed super fund sector. Clarity around a range of issues that were frustrating both trustees and professionals within the SMSF industry can now move forward with some comfort.
NB. It is important to remember that this is a draft ruling currently available for public comment and represents the Commissioner’s preliminary views on limited recourse borrowing arrangements. Comments are available to be made on the draft Ruling until 28 October 2011.
I would be interested to hear readers thoughts and comments on this draft SMSF Ruling…