It quite amazing how far we have come with limited recourse borrowing arrangements over the nearly 2 years since changes were introduced on 7 July 2010. Many people would recall at that time of the introduction of sections 67A and 67B into the SIS Act that many within the industry were highly critical of the very strict limitations that appeared to be imposed with the single acquirable asset definition, along with the supposed inability to make any changes to a particular asset held under such a borrowing arrangement.
The final SMSF ruling, SMSFR 2012/1 on the application of key concepts with limited recourse borrowing arrangements has certainly seen this view come full circle as the practical approach taken by the Commissioner within this ruling provides both clarity and some exciting opportunities for the acquisition of real property within a self managed super fund.
With the property market facing its own challenges in respect to attracting buyers, we have seen a shift with property developers looking to target the SMSF market to promote property to trustees as part of their fund’s investment strategy. The original draft ruling issued in September 2011 provided clarity around the ability for a fund to acquire off-the-plan apartments, where the borrowing arrangement was entered into at the time the property was completed and strata-titled. It appears that the final ruling, SMSFR 2012/1, has expanded the Commissioner’s view in respect to how a LRBA can be entered into to acquire property to be developed (whether an off-the-plan apartment or house and land).
So what has changed from the draft ruling to the final ruling in respect of property development?
The draft ruling discussed that a borrowing could only be entered into for an off-the-plan purchase once the property had been completed and strata titled. This meant that the SMSF was required to fund the initial deposit and then obtain the SMSF limited recourse loan for the completion of the property. This view appears to have slightly changed within the final ruling whereby, if a contract is entered into for an off-the-plan purchase of a strata titled unit (that is, the purchase of a unit that is yet to be built and strata titled) and under the contract a deposit is required upon entering into the contract with the balance payable at settlement after the unit is built and strata titled, each payment is applied for the acquisition of that strata titled unit. Providing that the strata titled unit is a single acquirable asset, the deposit and the balance payable at settlement may be funded under a single LRBA.
The final ruling also expands in the construction of a house on land through the use of a limited recourse borrowing arrangement. Previously it has been the understanding that when it came to the development of house and land, the draft ruling inferred that the land was the single acquirable asset and once a property is added it becomes a different asset (replacement), which is not permitted under section 67B. Whilst this to some extent remains true, the final ruling outlines that a similar outcome results (to a OTP apartment) if the contract entered into is for the purchase of a single title vacant block of land along with the construction of a house on that land before settlement occurs. In this situation the deposit paid upon entering into the contract and the balance payable upon settlement is applied for the acquisition, under that contract, of land with a completed house on it. The deposit and the balance payable at settlement may be funded under a single LRBA.
The ruling provides two examples of how structuring the purchase of house and land will ultimately dictate what is a single acquirable asset:
Purchase of land and construction of house using borrowings
The trustees of an SMSF want to enter into a LRBA where the single acquirable asset is a vacant block of land. The SMSF intends that the borrowing will provide sufficient funds for the construction of a house on that block. Assuming that title to the vacant land transfers to the holding trust prior to the house being built, it is the vacant land that is acquired and held on trust under the LRBA . This arrangement will cease to satisfy the requirements of section 67A if money borrowed under the LRBA is subsequently used to construct the house and thus improve and fundamentally change the character of the asset held on trust (that is, from vacant land to residential premises ). This outcome is not altered even if the contracts entered into for the acquisition of the land and the construction of the house contain clauses linking the two contracts .
Acquisition of a yet to be constructed house on land using borrowings
The trustees of an SMSF want to enter into a contract to acquire, as a ‘package’, land with a yet to be constructed house on it and to fund the acquisition using borrowings under a LRBA. As the contractual arrangement is for the acquisition of land with a completed house on it, and settlement occurs once construction of the house is finished, the deposit and the payment on settlement can be funded under a single LRBA .
It is the Commissioner’s view that the second arrangement is for the acquisition of a single acquirable asset, being the land with the house constructed on it, as distinct from the first where the single acquirable asset is the land only.
The view’s expressed within this final ruling certainly open the doors for SMSF trustees to consider a greater range of new property development opportunities using limited recourse borrowing arrangements. I think it would be fair to say property developers will certainly be ready and waiting.