Limited recourse borrowing arrangements for SMSFs

Normally a SMSF is restricted from borrowing money to purchase assets to be held by the fund (S67 of the SIS Act). However there is one exception to this ruling, which is a Limited Recourse Borrowing Arrangement (LRBA).

Under a LRBA a SMSF can borrow money as long as the lender uses only the asset being purchased as security, that is, the lender's recourse is limited only to the purchased asset. However, Trustees should always consider the quality of the investments and whether the fund can meet all of the future obligations under the arrangement.

A Trustee can only enter into such an arrangement where the purchase of the asset is consistent with the investment strategy of the fund and the governing rules of the fund allow the trustee to enter into any borrowing arrangement.

ATO legislation states, if your SMSF chooses to use a LRBA, then the arrangement must satisfy the following conditions:

• The fund uses the borrowed monies to purchase a single asset, or a collection of identical assets that have the same market value (that together are treated as a single asset). For example, you can borrow to purchase shares in the one company, but you would need to take out another LBRA if you intend to purchase shares in another company
• The borrowed money cannot be used to improve the purchased asset
• The asset is held on trust so that the SMSF receives the beneficial interest in the purchased asset
• The SMSF has the right to acquire the legal ownership of the asset by making one or more payments
• Any recourse the lender or any other person has under the LBRA against the SMSF Trustee is limited to the single fund asset (including the rights to income)
• Replacing the asset subject to the LRBA is possible in very select circumstances, ie if a company undertakes a share split or if there is a company takeover or merger.

If the fund chooses to purchase a property, then significantly, the fund cannot borrow to make improvements to the property (see article on Repair v improvement in a SMSF property asset). However, the fund may use its own cash reserves to undertake improvements to the property. Alternatively, a fund may have tenant pay for the improvements. While this is a valid strategy, the Trustee must be aware of:

1. Improvements to a property made by a related party may be considered to be a contribution (TR 2010/1 para 11), including any DIY maintenance the Trustee may carry out themselves; AND
2. If the Trustee purchases the materials in their personal name and then reimburses the money from the fund, this may breach the "acquisition from related parties" clause in the SIS Act.

Before, you enter into any LRBA in a SMSF, ensure that you seek advice regarding the dos and don'ts and ensure your fund remains complaint at all times, otherwise any capital growth on the asset may go straight to the ATO's piggy bank.

For more information on SMSF compliance and regulations, please contact our wealth team.