Limited recourse borrowing arrangements
17 November 2022
Self-managed super funds (SMSFs) are not allowed to maintain borrowings in most instances, but there are some limited exceptions under superannuation law that allow borrowings. The most common exception available for current modern SMSFs are limited recourse borrowing arrangements (LRBAs).
LRBAs were originally designed to protect the other assets of the SMSF, which allows the borrowing to be applied to a single acquirable asset (or collection of assets all at the equivalent market value) that is held in a separate trust, or more often referred to as a bare trust. This means the other assets of the fund aren’t at risk as the borrowing is in limited recourse, so if upon default, the creditor (lender) only has recourse to the asset in the bare trust, not the other assets of the super fund.
When the LRBA is executed well with sufficient financial planning tailored to meet the needs of the targeted investor, LRBAs can be an effective part of an investment strategy. However, following the relevant rules and having all the complete and accurate paperwork is incredibly important for the trustees to manage it effectively. When executed poorly all sorts of problems can occur, for example, double or even triple stamp duty, confusion over ownership, and SMSF audit problems can also prove costly.
The intention of this article is to provide some necessary information to assist in the prevention of problems that may occur during the SMSF audit when a LRBA is in place.
Key information and requirements
The borrowed money can be used for conveyancing fees, loan application fees and stamp duty.
The borrowing can be refinanced.
The asset must be held on a trust (bare trust) by a custodian (bare trustee) so that the fund acquires the beneficial interest in the asset at the same time as entering the borrowing arrangement and the custodian has the legal interest (title holder). Please note that it is important that the asset or collection of assets are clearly listed on the bare trust in a schedule as appropriate.
The borrowing must be held by the super fund trustee as trustee for the super fund.
The fund may acquire the legal interest in the asset or collection of assets once all repayments have been made.
A charge may be granted to the lender(s) over the asset(s) held in the bare trust (but not the fund’s assets).
A copy of the signed loan agreement (including the agreement terms and conditions) and the signed bare trust must be kept on a permanent file by the trustee(s).
Whilst an asset is subject to a LRBA, it must not be replaced in a manner that constitutes the ‘replacement’ of the original asset. Once the original asset is replaced the LRBA ceases, if borrowings still exist and the LRBA has ceased then this results in a contravention of superannuation law.
Investment returns from the asset(s) go to the super fund.
Ensure the fund can meet all future obligations under the arrangement.
The arrangement is consistent with the investment strategy and borrowings are considered in the strategy.
The super fund trust deed and its governing rules allow for limited recourse borrowing arrangements.
The arrangement meets the requirements and superannuation laws and is in limited recourse.
In most cases the bank requires personal guarantees, therefore while other super fund assets may be protected, the bank could claim other personal assets in case of default. It is essential to read the loan terms & conditions thoroughly.
Ensure enough funds are always in the super funds bank account to make the necessary repayments, bank overdrafts can result in a contravention. Also consider what will happen if one of the members leave the fund.
Provide the complete financial years loan statements to the auditor with each annual SMSF audit.
If the LRBA lender provider is a related party please ensure the loan is consistent with what an arm’s length lender dealing at arm’s length would accept. The ATO safe harbour guidelines should be considered to provide some assurance.
Ensure the fund continues to always comply with all other superannuation laws.
Considerations
Most importantly, before the trustees consider the introduction of any type of LRBA as an investment vehicle for the SMSF, we recommend they seek advice from a SMSF professional to assist in determining if a LRBA is appropriate for the SMSF.
Borrowing strategies are not appropriate for everyone and in some cases can pose a significant risk to some individuals retirement savings, particularly when they have a low balance and cannot make repayments. Saying this, the introduction of LRBAs has been an important advancement in the diversification possibilities for the SMSF sector and we see them used quite widely for commercial property as well as residential property.
Recent evidence from research has found that SMSFs that have diversified investment portfolios in some instances outperform others that do not. We recommend this is considered when seeking advice from a SMSF professional as it may significantly improve the performance of the SMSF and reduce the associated risks involved with a LRBA.
It is also necessary to keep up to date with all the current ATO news & guidelines regarding the superannuation laws including LRBAs, as regular reviews are done by the ATO and the Council of Financial Regulators.
For any further information on what is required regarding LRBAs please get in touch with our team.
This information is provided for your assistance and education about LRBA’s. We have provided factual information that is not intended to imply an opinion or recommendation. You should consider obtaining appropriate advice before making any decision about LRBA’s.
By George Kemp
SMSF Auditor
