Super law requirements for LRBA

General prohibition on borrowing

Subject to limited exceptions allowed under SISA, trustees of SMSFs are prohibited from borrowing money. One of these exceptions is for limited recourse borrowing arrangements (LRBA). Different rules apply depending on when the arrangement was entered into.

Advice about the general prohibition and a list of exceptions is given in the ruling SMSFR 2009/2 Self-Managed Superannuation Funds: the meaning of 'borrow money' or 'maintain an existing borrowing money' for the purpose of section 67 of the Superannuation Industry (Supervision) Act 1993

Arrangements entered into on or after 7 July 2010

The rules for arrangements entered into on or after 7 July 2010 are contained in section 67A of the SISA (general rules) and section 67B of the SISA (replacement assets).

An SMSF is not prohibited from borrowing money, or maintaining a borrowing of money, providing the arrangement entered into satisfies each of the following conditions:

• The borrowed monies are used to acquire a single asset, or a collection of identical assets that have the same market value (that are together treated as a single asset), which the fund is not otherwise prohibited from acquiring (called the 'acquirable asset'). The new law makes it explicit that borrowed money applied to expenses incurred in connection with the borrowing or acquisition (such as loan establishment costs or stamp duty), or expenses incurred in maintaining or repairing the acquirable asset, is allowed.
• The borrowed monies are not applied to improving an acquirable asset.
• The acquirable asset is held on trust (the holding trust) so that the SMSF trustee receives a beneficial interest in the asset.
• The SMSF trustee has the right to acquire legal ownership of the acquirable asset by making one or more payments after acquiring the beneficial interest.
• Any recourse that the lender, or any other person, has under the arrangement against the SMSF trustee is limited to rights relating to the acquirable asset. This limitation applies to rights directly or indirectly relating to a default on the borrowing and related charges or directly or indirectly relating to the SMSF trustee's rights about the acquirable asset (for example, rights to income from the asset).
• The acquirable asset is not subject to a charge other than as provided in relation to the borrowing by the SMSF trustee.
• The acquirable asset can be replaced by another acquirable asset that the SMSF is not otherwise prohibited from acquiring, but only in very limited circumstances as listed in the super law.

See also

• SMSFR 2012/1 Self-Managed Superannuation Funds: limited recourse borrowing arrangements – application of key concepts
• section 67A and section 67B of the SISA

Arrangements entered into on or after 24 September 2007 and before 7 July 2010

An SMSF is not prohibited from borrowing money, or maintaining a borrowing of money, providing the arrangement entered into satisfies each of the following conditions:

• The borrowed monies are used to acquire an asset that the fund is not otherwise prohibited from acquiring.
• The asset acquired (or a replacement asset) is held on trust (the holding trust) so the fund receives a beneficial interest in the asset.
• The SMSF has the right to acquire legal ownership of the asset (or, if applicable, the replacement asset) by making one or more payments after acquiring the beneficial interest.
• Any recourse the lender has under the arrangement against the SMSF trustee is limited to rights relating to the asset acquired (or, if applicable, the replacement asset). For example, the lender can have the right to recover outstanding amounts where there is a default on the borrowing by repossessing or disposing of the asset being acquired under the arrangement but cannot have the right to recover such amounts through recourse to the fund's other assets.

The circumstances in which an acquirable asset in an LRBA can be replaced are listed in section 67B of the SISA.

Regulations can be made to allow for replacement in additional circumstances, but to date no regulations have been made for this purpose. The circumstances listed in section 67B are:

• A share in a company (or collection of such shares) can be replaced by a share (or collection of such shares) in the same company if, at the time of replacement, the original asset and replacement have the same market value (for example, if there is a share split). (Subsection 67B(3)).
• A unit in a unit trust (or collection of such units) can be replaced by a unit (or collection of such units) in the same unit trust if, at the time of replacement, the original asset and replacement have the same market value. (Subsection 67B(3)).
• If the original asset is an instalment receipt that converts to a share or collection of shares in a company, then that share (or collection of shares) is allowable as a replacement asset. (Subsection 67B(4)). For these purposes an 'instalment receipt' is defined to mean an investment under which a listed security is held in a trust until the purchase price of the security is fully paid and the security, and property derived from the security, is the only property of that trust. (Subsection 10(1)).
• A share in a company (or collection of such shares) can be replaced by a share (or a collection of such shares) in another company if the replacement occurs because of a takeover, merger, demerger or restructure of the first company. (Subsection 67B(5)).
• A unit in a unit trust (or collection of such units) can be replaced by a unit (or collection of units) in another unit trust if the replacement occurs because of a takeover, merger, demerger or restructure of the first trust. (Subsection 67B(5)).
• A share in a company (or collection of such shares) can be replaced by a stapled security (or collection of such securities) if the replacement occurs under a scheme of arrangement of the company – for example, as part of a restructure. The stapled security must consist of a share (or a single collection of shares of the same class) stapled together with a unit (or a single collection of units of the same class) in a unit trust. (Subsection 67B(6)).
• A unit in a unit trust (or collection of such units) can be replaced by a unit (or collection of units) in that trust if the replacement occurs as a result of an exercise of a discretion granted to the trustee of that unit trust under the trust deed (for example, a managed investment scheme trustee exercises a discretion to split or consolidate units). (Subsection 67B(7)).

When an LRBA does not satisfy all required conditions

If the required conditions are not satisfied, borrowing money under the arrangement will result in a contravention of one or more of the super laws. Such a contravention may have civil or criminal consequences.

Marketed instalment warrant products

A borrowing is allowed under any arrangement that meets the requirements of the super law, not just financial products marketed as instalment warrants.

Conversely, it does not automatically follow that a product marketed as an instalment warrant meets the conditions of the super law.

The rules allowing limited recourse borrowing are not limited to investments in instalment warrants traditionally offered by financial institutions where the underlying asset is a listed security. Other arrangements or products are allowed if they satisfy all of the requirements of the super law.

Changes resulting in a new arrangement

If the parties adopt a change to the terms or conditions of an arrangement (either expressly or by inference) that goes to the root of the arrangement – that is, it alters the character of the arrangement in a significant way – then there is a new arrangement from that time and the earlier arrangement has come to an end. If that change happened after 7 July 2010, the requirements of section 67A of the SISA apply to the arrangement.

Changes resulting in a new arrangement include:

• The borrowing under the original arrangement is refinanced – refer to    
  • Can an SMSF trustee refinance a limited recourse borrowing without contravening the super law?
  • Arrangements entered into on or after 24 September 2007 and before 7 July 2010, then refinanced on or after 7 July 2010
   
• There is a borrowing (drawdown) that is inconsistent with the earlier arrangement – for example, borrowing to acquire an asset or class of asset clearly not contemplated under the original arrangement
• There has been a change to the ultimate beneficiaries of the arrangement resulting from selling a structure involving a pre-existing arrangement.

Conditions for refinancing an LRBA

Arrangements entered into on or after 7 July 2010 and then refinanced at a later date

An LRBA can be refinanced provided the re-financed arrangement meets the requirements of section 67A of the SISA.

Section 67A explicitly allows re-financing of a borrowing (including any accrued interest) under an arrangement if the new borrowing arrangement is over the acquirable asset from the first arrangement (including an asset from the first arrangement that is a replacement asset under section 67B of the SISA) and no other acquirable asset.

Where a new trust is created to hold the asset, SMSF trustees must ensure that the asset is transferred directly to that new trust and that the SMSF does not temporarily obtain title to the asset at that time, otherwise a contravention of the super law will occur.

Arrangements entered into on or after 24 September 2007 and before 7 July 2010, then refinanced on or after 7 July 2010

SMSF trustees can refinance the borrowing, but the refinanced arrangement must meet the requirements of the law applying to LRBAs entered into on or after 7 July 2010.

A new borrowing that takes the place of the old borrowing, such that the application of the new borrowing is solely to extinguish the previous borrowing and meet associated costs, satisfies the requirement that borrowed funds are applied for the acquisition of the relevant asset.

However, refinancing the borrowing is entering into a new LRBA at the time of refinancing. Any arrangement refinanced on or after 7 July 2010 must meet the requirements of the super law (section 67A of the SISA) applying to arrangements entered into on or after 7 July 2010.

Where a new trust is created to hold the asset, SMSF trustees must ensure the asset is transferred directly to that new trust and that the SMSF does not temporarily obtain title to the asset at that time, otherwise a contravention of the super law will occur.

Find out about existing fund assets.

Varying the terms of a limited recourse borrowing

Varying the contract of borrowing does not always result in the end of the previous borrowing and the creation of a new and different borrowing (a refinancing).

This depends upon the nature and extent of the variation and the intention of the parties.

In Roberts v I.A.C (Finance) Pty Ltd (1967) VR 231, the parties agreed to extend a three-year borrowing for a further two months. It was held the extension was not totally inconsistent with the terms of the original agreement as the variation left the terms and conditions of the original agreement intact, except to the limited extent that the due date was extended by two months. As the contract was modified to a limited extent, the rights and obligations of the parties were not affected by the variation. In these circumstances, the loan extension did not discharge the original obligation to pay and create a new obligation to pay in its place.