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Self Managed Superannuation Funds (SMSF) - New Guidance for SMSF Instalment Warrants

Date: November 28, 2011

Authors: Jonathan Lim B.A., LL.B. (Hons)

New draft ATO guidance is now available for the use of instalment warrants by self-managed superannuation funds. The instalment warrant system (officially “limited recourse borrowing arrangements”) permits SMSFs to borrow money, under restricted circumstances, to acquire an asset.

However, many SMSFs attempting, or claiming to attempt, to use the instalment warrant system honestly, have been in breach of the rules, hence the new guidelines (Draft SMSF Ruling SMSFR 2011/D1, released September 2011).

The ATO’s draft guidelines cover the following major topics:

  • clarification on what is a “single acquirable asset” under the rules;
  • what constitutes maintaining or repairing the asset rather than improving it; and
  • clarification on when the asset changes so much that it becomes a new asset.

Single acquirable asset

Because the lender’s recourse must be limited to the asset the subject of the warrant, an important issue is what constitutes a single acquirable asset.

The ATO’s approach is that where the SMSF appears to be acquiring separate proprietary rights, it will treat these rights as forming a single asset where is would be reasonable to conclude that the object of the rights is distinctly identifiable as a single asset. However, if the assets can be dealt with separately, then they are multiple assets, even if the vendor purports to treat them as a single asset.

Repairs and maintenance

One of the instalment warrant rules, is that the borrowed funds may be used in carrying out repairs and maintenance to the asset, but not its improvement.

In this case, the ATO treats payments as being for maintenance where they are to prevent future defects, damage or deterioration and to preserve the asset in its present state. Payments are for repairs where they make good defects, damage or deterioration to the asset, restoring it to its former condition.

Improvements to the asset, which may not be paid for from the borrowed amount, include anything that substantially increases the functional efficiency or value of the asset, through addition of features/rights or through bringing the asset to a more desirable condition.

Whether the change to the asset mere restores its former condition, or actually improves it, is a question of fact and degree in each case.

A new asset

The asset that the SMSF finally acquires when the last instalment is paid off, must be the same asset that was the subject of the warrant in the first place. This raises the issue of whether the asset has been replaced.

The ATO’s approach is that, in the case of real property, subdivision, building on vacant land, demolition and replacement of buildings and rezoning all cause the asset to become a different asset. However, the mere replacement of a building after a natural disaster would not result in a replacement asset.

Example: Instalment warrant and the acquired asset

A, B and C are members and trustees of the same SMSF. They want their SMSF to invest in a particular property in Canley Vale NSW. The property is currently zoned for commercial premises, and consists of a halal butcher, a mattress shop and an electronics store in adjacent buildings on the one block of land.

A, B and C set up a fixed trust with the SMSF as the sole beneficiary. They borrow $300,000 from X Bank. They acquire the land and it goes into the fixed trust. The SMSF will only acquire full title to the land when A, B and C pay off the last instalment of the $300,000 to X Bank. X Bank’s recourse against the SMSF is limited to the land itself.

A, B and C have spent $200,000 acquiring the land. However, they also do the following:

  • they spend $20,000 repairing the guttering, replacing a sagging fence and replacing some tiles on the roof;
  • they spend $80,000 in a complete renovation of the premises, turning them into three attractive new apartments; and
  • they apply for and are granted a rezoning of the land from commercial to residential premises.

In this case, the land originally qualifies as being a single asset. The repairing of the guttering, replacing of the fence and replacement of the tiles would probably constitute repairs or maintenance, and thus would be permitted under the instalment warrant rules.

However, the complete renovation of the premises and the rezoning of the land result in the asset becoming a new asset, and thus breaches the superannuation rules.

Conclusion

If you have concerns about what you are permitted to do to an asset that is subject to an instalment warrant, call LAC Lawyers and we can provide advice and assistance.  

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