Keep the guidance coming

Kris Kitto posed some questions in relation to a previous posting about the recent limited recourse borrowing amendments, and in particular on the question of whether an improvement constitutes a replacement. I thank Kris for his questions, and apologise for not responding earlier. I had delayed my response in the hope that there may be some guidance from the ATO. And whilst we have seen several recent Interpretative Decisions, it seems that until the ATO is asked to make a specific determination on the issue, we are left to make our own assessment of how the provisions apply.

Kris asked

Can a property within a new S67A instalment warrant arrangement be improved by using other SMSF cash (i.e. from contributions etc) without breaching the
new provisions?

When does a replacement asset come about by way of improvements made?
Does it mean 'substantial' improvements or any old minor improvement that can't
be considered a repair?

In the context of improvements, the legislation only takes issue where the borrowed money is applied in improving the acquirable asset. The legislation is silent on the fund using its own money to undertake the improvement.

As for whether improvement creates a replacement asset, there is no specific reference in the legislation itself. Rather, the legislation contemplates that there be 'another single acquirable asset'. In the case of real property where the asset is a particular lot, it seems to me that improving the asset does not result in there being 'another ... asset', unless the lot is exchange for another or others, or perhaps where the lot becomes subject to an encumbrance (eg an easement). Even 'substantial' improvements seem unlikely to cause there to be 'another ... asset'.

That said, there is always a need to tread carefully in this new area. I look forward to the ATO providing some guidance in the near future.

Limited recourse borrowing and the ATO

The ATO released an Interpretative Decision last Friday addressing one aspect of a limited recourse borrowing arrangement - that is whether an SMSF trustee contravenes section 109 SIS if it borrows money from a related party under a limited recourse borrowing arrangement on terms favourable to the SMSF.

Correctly, the ATO concluded that this does not breach section 109.

What the ID doesn't say is whether this creates any other issues for the arrangement. Yesterday, Money Management posted an article (ATO SMSF decision queried Money Management) suggesting that the ATO had given the "green light" to SMSFs borrowing from related parties on beneficial terms. And an article in today's AFR has a similar flavour.

Comments made both within those articles and in response to them suggest on the one hand that caution should be exercised, but on the other hand that there are wider opportunities to be exploited.

I would suggest a more cautious approach be adopted. The ID had a very limited scope - the application of section 109. It makes no comment about other issues including:

• whether the discount to the arm's length rate of interest enjoyed by the superannuation fund is a contribution?


• whether the arrangement gives rise to non-arm's length income to the SMSF

I expressed concern in an earlier post about the Cooper Review recommendation of a general review of superannuation borrowing in 2 years' time. It seems to me that when comments begin to surface pushing the interpretation of announcements far beyond the limits clearly intended, the industry runs the risk of losing the concessions that for the most part are not abused.