The latest draft ruling released by the ATO seeks to clarify their position on a number of issues around limited recourse borrowing arrangements (LRBA).
The ATO position shows a common sense and commercial approach being shown.
Whilst it’s a fairly involved ruling, the following is a summary of the key points covered:
1. A single acquirable asset may now be over multiple titles.
A key issue with LRBAs is that a single LRBA can only be over a single acquirable asset. Previously, the understanding was that you could not do a single LRBA over a property that had multiple titles. However, the ATO have now said that it is important to consider both “the legal form and substance of the asset acquired” particularly where an asset is distinctly identifiable as a single asset.
What this means is that if you have a building on multiple titles of land and clearly the building cannot be dealt with separately from the land, then this is OK now for a LRBA.
However, an asset is NOT a single acquirable asset if the assets can be dealt with separately, or if it is merely because the vendor wants to deal with the assets as a package or the lender will only lend over a group of assets, unless there are other laws of a State or Territory preventing the assets being dealt with separately.
The following examples help clarify what is (and what is not) now deemed a single acquirable asset.
Example of a single acquirable asset: A factory building on more than one title
An SMSF trustee wants to acquire a factory using a LRBA, however the whole factory covers two separate legal titles. In this case, the factory is a single acquirable asset and can be acquired under one LRBA.
Other examples of situations that are considered a single acquirable asset include:
- completed ‘off the plan’ apartment. The deposit is not LRBA, but once the apartment is complete and strata-titled, then a LRBA can be used.
- Apartment with separate car park, on separate titles, but where the laws of the state say they cannot be separately disposed of.
Example of NOT being a single acquirable asset: Two adjacent blocks of land
In a situation where a SMSF trustee wants to buy land, but the seller will only sell the two blocks together (even though there are no physical or legal impediments to the two blocks of land being sold separately) then this is NOT a single acquirable asset, and as such the two blocks of land cannot be acquired under one LRBA. To purchase both would require separate LRBAs.
Other examples of situations that are considered NOT to be a single acquirable asset for LRBAs include:
- farmland with multiple titles, where there is no legal or physical impediment to the land represented by the different titles from being dealt with (sold off) separately.
- Building a house in-situ on a block of land
- An apartment where the seller will only sell with a furnishing package included. The apartment without the furnishings is OK and can use a LRBA, but not with the furnishings package included.
2. Clarifying the difference between repairs and improvements
A key requirement of LRBAs is that borrowed money can be used to fund repairs and maintenance of an asset, but cannot be used to improve an asset.
The ATO go to great lengths to explain the difference between them. However the easiest way to understand it is to look at the examples they provide below:
|
Repair or maintenance example |
Improvement example |
|
|
1. |
A fire damages a part of the kitchen (cooktop, benches, walls and ceiling). Restoration of the damaged part of the kitchen would constitute repair of what is a subsidiary part of the asset being the house and land. |
If the kitchen was also extended by extension of the house this extension would be an improvement. |
|
2. |
The guttering on the house is replaced and the house is repainted. A fence is replaced. A fire alarm is installed to comply with new council requirements. This would be repair or maintenance. |
The addition of a new pool or a new garage would be an improvement. |
|
3. |
A cyclone damages the roof of the house. Replacement of the roof in its entirety is a repair. |
The addition of a second storey to the house at the time of also replacing the roof would be an improvement. |
|
A farm (on a single title) is the single acquirable asset under an LRBA. At the time of entering into the LRBA the farm includes one set of cattle yards, four bores including windmills, tanks and troughs and three kilometres of fencing. |
||
|
4. |
Replacing a section of the cattle yards or the existing fencing is a repair. Ensuring the bores, windmills, tanks and troughs continue working is repair or maintenance. This would include laying new pipes between the tank and trough. |
Each of the following additions is an improvement:
|
3. It is now OK to “improve” an asset, as long as you don’t use borrowings to do it or improve it so much it becomes a ‘different’ asset.
One of the real contentious issues around LRBAs up to now has been the general acceptance that if you had borrowed to invest in a “single acquirable asset”, you could not do anything to ‘improve’ the asset. The position now is that it is OK to improve an asset, as long as you don’t use borrowed monies to do it (i.e. you need to use other money in your SMSF), and don’t change the fundamental nature of the asset such that it becomes a different asset.
And so of course the next big question is – what does it mean to fundamentally change the nature of the asset ?
The ATO state that it is necessary to consider both the qualities of the physical object and the proprietary rights comprising the asset, to determine if the character of the asset as a whole has fundamentally changed.
Again, the easiest way to understand it is to look at some examples:
Examples where improvements are OK (i.e. don’t result in new asset(s)):
- your SMSF owns an old 2 bedroom apartment using a LRBA. You decide to improve the apartment by renovating it, with new carpets, new paint, new kitchen benches etc. You use existing money inside your SMSF to pay for the renovations – not money from a LRBA.
- your SMSF owns a five bedroom house using a LRBA. A fire (or flood) then destroys the house. Using insurance proceeds, you rebuild the same type of five bedroom house. The fundamental character of the asset has not changed.
Examples where improvements are not OK (i.e. result in new asset(s)):
- your SMSF acquires a vacant block of land using a LRBA, and you then subdivide the land resulting in two separate titles – or you build a house on the land.
- your SMSF buys a house which is built over two titles using a single LRBA, and the house is then relocated so that it stands on only one of the titles.
- your SMSF buys an existing five bedroom lowset brick house on land using a LRBA. The house is then completely destroyed by fire. Using insurance proceeds, instead of constructing the same type of house, you instead construct two, two bedroom units on the land following approval for dual occupancy.
