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SMSFs can’t borrow money, except…

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Regardless of the lender, super law prohibits SMSF trustees from borrowing money or maintaining an existing loan.

A transaction will be considered borrowing if:

  • there is a temporary transfer of an asset from a lender to a borrower; and
  • there is an obligation or intention to return the temporarily transferred asset to the lender.

The legislation states that the asset borrowed must be money, although the borrower may provide an asset (or other money’s worth) in satisfaction of their obligation or intention to repay the lender.

The fine print

There are three strict exceptions to the borrowing rule.

1. To fund a payment to a beneficiary
This enables the SMSF to undertake a temporary loan to make a payment to a beneficiary, which the trustee is required to make by law or by the SMSFs governing rules, and which the trustee wouldn’t be able to make without the borrowing. The borrowing period must not exceed 90 days and the total amount borrowed must not exceed 10% of the value of the SMSF assets.

2. To cover settlement of certain securities transactions
The purpose of the loan is to enable the trustee to cover the settlement of a transaction for the acquisition of certain securities. Examples include listed shares, units in a unit trust, bonds and debentures, futures and forward contracts, swap contracts, rights or options over these securities and foreign currency. The loan period must not exceed seven days and the total amount borrowed must not exceed 10% of the value of the SMSF assets. Importantly, at the time the relevant investment decision was made, it was likely that the loan would not be needed.

3. Allowing the SMSF to acquire an asset under certain limited recourse borrowing arrangements (LRBA)
This is a complex piece of legislation which allows the SMSF to borrow to acquire a single acquirable asset that is held in a holding trust so that the trustees acquire a beneficial interest in the asset. The trustee has a right to acquire legal ownership of the asset by making one or more payments after acquiring beneficial interest, and the rights of the lender (or any other person) against the trustee in connection with the borrowing and other charges are limited to that asset only. Acquirable assets are any assets that an SMSF is permitted to acquire under general super law.

There are specific rules around the holding trust, what constitutes a single asset, in which circumstances assets can be replaced, and whether assets can be repaired or improved.

What is and isn’t ‘borrowing’?

Examples of circumstances that are classified as borrowings:

  • Loan of money, either secured or unsecured
  • Margin lending accounts
  • Bank overdrafts
  • Sale and repurchase agreements

Examples of circumstances that are not classified as borrowings:

  • Contracts for difference (CFDs)
  • Installment purchase agreements with immediate use of assets
  • The liability of an SMSF to pay benefits to members as they fall due
  • Arrangements under which expenses are paid on behalf of the SMSF trustee by any person where reimbursement is immediately sought from and made by the SMSF
  • Normal commercial delays in the payment of expenses incurred by an SMSF trustee

The borrowing prohibition extends to granting a charge against an asset of the SMSF. This includes a mortgage, lien or any other encumbrance. Therefore, an SMSF can’t use existing assets as security for any dealings.

The borrowing exceptions are strict in application, and breaking these rules could result in civil and criminal penalties, and may jeopardise the complying status of the SMSF.

With respect to LRBAs, it’s imperative that the arrangement is set up correctly to avoid unnecessary tax and duties when the asset is transferred to the SMSF. It’s prudent to seek advice on these structures from your financial planner or SMSF adviser.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

Published on: Saturday, September 01, 2012

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