SPAA Education and Professional Standards Director Graeme Colley says: “There is a place for gearing strategies to help people grow their retirement savings, but it’s imperative they understand the risks involved before going down this path. 

“People have to understand that a limited recourse borrowing arrangement that doesn’t comply with government regulations can have serious financial consequences for trustees.” 

Mr Colley says SPAA’s strong position on limited recourse borrowing – it issued a fact sheet detailing the risks late last year – means it fully supports the Federal Government’s move to change the Corporations Regulations to have these borrowing arrangements designated a financial product. 

“If this change can be implemented, it will mean that only professionals licensed to provide financial advice  can advise on limited recourse borrowing arrangements, and they will be required to consider a client’s complete financial circumstances, not just those that relate to the borrowing arrangement in isolation.” 

He says SPAA’s only major point of difference with the Government’s proposed changes is to not treat limited recourse borrowings in the same way as a derivative. 

“SPAA contends that the value of a derivative is based is obtained from the underlying asset, such as options over shares, which is a quite different arrangement to a debt facility that has be organised to buy an asset for a superannuation fund.”

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SPAA Technical Director Peter Burgess says: “A gearing strategy can assist people grow their retirement savings, but there are significant risks that must be considered before embarking on this strategy; it’s very much a case of look before you leap. 

“In particular, there has been a lot of discussion recently around limited recourse borrowing arrangements for SMSFs, and while they can offer benefits to fund members, a non-complying arrangement can have dire financial consequences for trustees if they are unaware of the pitfalls.” 

In a comprehensive fact sheet, which is designed to be issued by SMSF practitioners to alert and educate their clients, Burgess detailed several key risks. They include: 

• Only assets that the SMSF trustee is not otherwise prohibited from acquiring can be bought under a limited recourse borrowing arrangement. Although there are exceptions, this generally means that assets a trustee or a related party own cannot be bought under this arrangement.
• Assets acquired under this arrangement cannot generally be replaced with a different asset. In practice, this means alterations to a property cannot be made if it fundamentally changes the character of the asset.
• There may be additional costs associated with acquiring an asset under this arrangement.
• Loan repayments are deducted from a fund, meaning it must always have sufficient liquidity to meet repayments.
• The Australian Taxation Office has become aware that certain limited recourse borrowing arrangements have not been structured correctly. In these cases it’s not simply a matter of restructuring the arrangement. Rather, it has to be unwound, often at a substantial loss.

Burgess stresses there are benefits from these borrowing arrangements, such as giving trustees the opportunity to leverage their superannuation savings, tax concessions, and asset protection when bankruptcy occurs. 

“Used in the right circumstances and structured correctly, there can be considerable benefits associated with these borrowing strategies. But SPAA is concerned that some people are seeing this type of borrowing as a way into a property investment without realising the potential downside. 

“Many seminars and written articles have been devoted to explaining the benefits of these arrangements without necessarily pointing out all of the risks. It’s for this reason we issued the fact sheet which explains the key benefits as well as the key risks,” he says.

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This draft ruling explains important concepts about limited recourse borrowing arrangement (LRBA) provisions as they apply to SMSFs. The key concepts explained are:

• what is an ‘acquirable asset’ and a ‘single acquirable asset’
• ‘maintaining’ or ‘repairing’ the acquirable asset as opposed to ‘improving’ it
• when a single acquirable asset is changed to such an extent that it is a different (replacement) asset.

 Refer to SMSFR 2011/D1 Self Managed Superannuation Funds: limited recourse borrowing arrangements – application of key concepts, which was published on 14 September 2011.

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