Changes to Limited Recourse Borrowing Arrangements

Limited recourse borrowing arrangements (LRBAs) have a very checkered history which will compound from 1 July, next year, if the proposed changes to the Total Super Balance become law.  

At the start, the Superannuation Industry (Supervision) Act 1993 allowed funds to borrow using an LRBA on the pretext that it would not taint other fund assets, should the fund default on the loan. These were amended to iron out some of abuses that developed.

Next, various enquiries told us that LRBAs were the devil in disguise for self-managed superannuation funds (SMSFs) and small APRA (Australian Prudential Regulation Authority) funds (SAFs) but not for others.

Now we see the super changes have brought them to light again with the commencement of the Transfer Balance Cap and Total Super Balance.

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Let’s look at the most recent assault on LRBAs introduced by the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018 which turned up in the House on 24 May.

Luckily, the bill has at least one consolation prize that lobbying does pay dividends. The original wider proposal in Treasury’s Exposure Draft is now limited to LRBAs with related party loans or funds with members who meet a nil cashing restriction.

The Government’s revised approach is much more focused and will minimise the likelihood of members who use LRBAs for genuine investment purposes being inadvertently penalised.

It also means many SMSFs with one or more members who enter into an LRBA from 1 July, 2018 will be spared the extra complexity of the original proposal which proportioned the outstanding LRBA loan balance between members.    

So how does the proposal work?

First of all, it doesn’t start until 1 July, 2018 and then only to LRBAs entered into from that time. The effect is to increase a member’s total superannuation balance by a proportion of the outstanding LRBA loan determined on the basis of all members’ balances in the fund.

And, it applies only where the LRBA supports at least one of the member’s superannuation interests when the total superannuation balance is determined on 30 June in the previous financial year.

To work out whether there is a connection between a fund asset and an individual’s interest you need to look at how assets have been allocated to meet the member’s current and future superannuation liabilities.

Where at least one fund member has a total superannuation balance of $1.6 million the fund is required to use the proportionate method and therefore the apportionment of the outstanding LRBA balance will apply to all members.

But, where the fund has all members with less than $1.6 million they have a choice to use the segregated or proportional basis as they wish.

If the segregated basis is used the fund can allocate various assets, including the value of the asset subject to the LRBA to a particular member’s superannuation interest.

Application of the nil cashing restriction will lead to a proportion of the outstanding loan to be added to the member’s total superannuation balance. The reason for this addition is due to the potential risk of a member withdrawing part of their fund balance and lending it back to the fund.

Without these new rules a proportion of the outstanding loan would not be added to the member’s total superannuation balance.

In some situations, a member who meets a nil cashing restriction may have their total superannuation balance increased where other members who do not satisfy the nil restriction will have no increase in their balance.

Where the LRBA includes a related party loan which is between the fund and an associate the amount of the outstanding loan is added to the member’s total superannuation balance.

An associate includes a member of a superannuation fund. This applies irrespective of whether a member meets a condition of release.

The following case study illustrates how the rules for LRBAs work when it comes to a person’s total superannuation balance:

Conor is 58 and works full-time. Jane is 60 and retired. Both are members of an SMSF. Conor has a balance of $900,000 in the SMSF and a balance in a retail superannuation fund of $300,000.  Jane has a balance in the SMSF of $1.2 million

During the 2018/19 financial year they decide to purchase an apartment through an LRBA. The cost of the apartment is $800,000 which is purchased with $500,000 provided by the fund and a $300,000 loan.

After acquisition of the property under the LRBA the total value of the fund's gross assets is $2.4 million which is made up of the property valued at $800,000 and the fund's assets of $1.6 million.  The fund has borrowed $300,000 from an external arm's length lender.

The amount of the outstanding loan is apportioned over Jane and Conor's balances in the SMSF.

The additional amount added to Jane's total superannuation balance is $171,000 (57 per cent of the outstanding LRBA). Jane's total superannuation balance will be $1.2 million plus $171,000 which will total $1.371 million.

However, in Conor's case no amount will be added to his total superannuation balance as he does not meet a condition of release and the loan is made with an arm's length lender. His total superannuation balance will stay at $1.2 million consisting of his balance in the SMSF and the amount he has in the retail superannuation fund.

The new rules bring with them a warning that artificially manipulating the allocation of assets under the LRBA will come under the cloud of Part IVA where the dominant purpose is to obtain a tax benefit.

The proposed change to calculating total superannuation balances brings with it an added checkered layer to the superannuation reform changes. 

Graeme Colley is SuperConcepts' executive manager, SMSF Technical & Private Wealth.