ATO provides clarity on SMSF property acquisitions
Stephen Miller outlines the key issues recently clarified in an Australian Taxation Office ruling regarding the acquisition of property by self-managed super funds using borrowed money.
On 23 May 2012, the Australian Taxation Office (ATO) released a ruling (SMSFR 2012/1) to outline how they intend to apply certain Limited Recourse Borrowing Arrangement (LRBA) provisions contained in the Superannuation Industry Supervision (SIS) Act.
While the ruling focuses primarily on real property, the principles may be applied to other types of assets. Key concepts that are explained by the ATO include:
- What is an 'acquirable asset' and a 'single acquirable asset';
- 'Maintaining' or 'repairing' the acquirable asset, as opposed to 'improving' it; and
- When a single acquirable asset is changed to such an extent that it is a different (replacement) asset.
The explanation of these concepts does not differ materially from what was contained in the previously released draft ruling that addressed this topic.
A key point of difference in the final ruling, however, was the greater clarity provided on the acquisition and development of property purchased with an LRBA.
This includes 'house and land packages', 'off-the-plan' purchases and options to acquire a property at a later date.
House and land packages
Often a house on a single-title block of land is acquired under a contract with a deposit paid upon entering into that contract and the balance payable at settlement.
Where this is done, each payment is considered to be applied for the acquisition of a single acquirable asset and may be funded under a single LRBA.
Conversely, if the self-managed super fund (SMSF) uses borrowed money to acquire a block of land, it cannot use further borrowings to construct a house.
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.
The interesting aspect of the ATO's position on this issue is that both options essentially result in the same outcome, but the consequences for the fund are quite different.
Off-the-plan purchases
Sometimes a contract is entered into for an off-the-plan purchase of a unit that is yet to be built and is strata titled, where a deposit is required and the balance is payable after the unit is built.
Provided the strata titled unit is a single acquirable asset, the deposit and the balance payable at settlement may be funded under a single LRBA.
While this clarifies the ATO's position on the purchasing of off-the-plan properties, such an outcome may not be possible.
This is because there will generally be no acceptable security for the lender at the time finance is required to pay the deposit.
The draft ruling did, however, provide an example of a fund that put up its own cash to pay the deposit and financed the settlement amount with an LRBA.
While this example was not contained in the final ruling, it is reasonable to conclude that such an arrangement would be acceptable.
Using options to acquire a property
Another way to purchase a property is to acquire an option for an off-the-plan purchase of a house on a single title block of land (or strata titled unit).
Where this is done, the relevant single acquirable asset is the option and the money applied to acquire the option may be funded under an LRBA.
However, the subsequent acquisition of the house and land (or strata titled unit) upon exercising that option would need to be funded under a separate LRBA.
This is because the asset acquired upon exercising the option would be a different asset to the option itself.
Like off-the-plan purchases, the practical implications for such an option arrangement is the option would be purchased with the fund's own resources and an LRBA would only be entered into to finance the settlement of the block of land (or strata titled unit).
Other issues
Collectively the concepts summarised above and other components of the ruling provide greater certainty for SMSF trustees who are interested in using an LRBA to acquire property.
However, there are still some issues the ruling doesn't address.
One such scenario is where someone has already paid a deposit on a residential property and wants to set up an SMSF and enter into an LRBA to finance the settlement.
A logical interpretation of the super rules would suggest that such a transaction would not be permitted.
This is because it could be considered an acquisition of a property from a related party, as the right to the property at the time the deposit was paid resided with the individual, not the yet-to-be established SMSF.
Another unresolved issue is where an SMSF has been established and enters into a contract to acquire a property before it has established a security trust to hold the asset.
In this scenario, it is reasonable to conclude that the SMSF is the owner of the asset and therefore an LRBA cannot be established.
An LRBA can only be set up for assets that are owned by a security trust, not an SMSF or other party.
These examples show that, although the ruling has provided some clarity, LRBAs are still complex arrangements.
For this reason, it is essential that trustees get expert advice and, in many cases, financial advisers will need to outsource components of the advice to other professionals.
Stephen Miller is a senior technical consultant at MLC Technical Services.
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