Stocktake on super borrowing rules


Monday 02 March 2015

As published in Professional Planner

There have been a number of developments relating to SMSF limited recourse borrowing arrangements (LRBAs) in recent months. For SMSF clients contemplating entering any type of LRBA in the foreseeable future the recommendations of the Financial System Inquiry panel (FSI) may influence current planning because, although not government policy, the recommendations may lead to new legal restrictions on LRBAs during the course of the next year or so. For clients exploring the prospect of arranging a low interest SMSF borrowing from a related party the Australian Taxation Office’s (ATO’s) recent interpretative decisions IDs 2014/39 and 40 will also be of immediate interest. Other clients will be concerned with recent ATO statements which cast doubt on the use of cross-insurance arrangements to support fund borrowings, while many will be comforted to know that the Government has released draft legislation to clarify the income tax treatment of instalment warrants and LRBAs.

Government’s response to the FSI

The FSI has effectively recommended the complete removal of the ability of super funds to establish LRBAs to purchase fund assets. Broadly, the FSI believes that the removal of LRBA leverage would reduce super system risk. More specifically, it doubts whether LRBAs are genuinely limited recourse by nature, particularly where supported by personal guarantees. It has also expressed concerns about LRBAs’ effect in reducing diversification and circumvention of contribution caps.

The key question is how the Government will respond to the FSI’s recommendations. Will it go so far as to completely remove the scope for LRBAs? Will it instead adopt a “middle ground” by introducing a combination of specific constraints on LRBAs? For example, FSI submissions of various industry stakeholders suggested constraints such as:

  • prohibiting personal guarantees
  • limiting loan-to-value (LVR) ratios or the amount which could be borrowed
  • requiring the terms of all loans to be completely commercial (not required under the current “arm’s length rule”; i.e. section 109 of the Superannuation Industry (Supervision) Act 1993 (SIS))
  • advice and product offer consumer protection requirements on relevant licensees along the lines originally proposed as part of the previous Government’s Stronger Super package.

Timing the transition

Assuming the Government ultimately decides to impose new constraints on LRBAs, there is a good chance existing arrangements will be grandfathered, as recommended by the FSI. Inevitably there will be issues to consider about the extent of grandfathering, such as the scope to refinance a borrowing down the track etc. Some commentators have even suggested putting related party loans in place now to address grandfathering issues which may arise if an existing arrangement with a commercial lender is required to be repaid early. However, the need for, or effectiveness of, such arrangements is difficult to predict in advance of any Government announcement.

As for the timing of any new constraints, it is unlikely that these will be announced or take effect before the Government has received submissions responding to the FSI. Submissions need to be lodged by 31 March 2015, which may suggest that a Government announcement on LRBAs is unlikely before the May Budget statements. Whatever the timing, SMSF clients contemplating entering an LRBA would need to be confident they have a grandfathered arrangement in place before any cut-off date. Ideally, the loan documentation would be completed, money borrowed and asset purchased. There may be issues if, for example, a trustee contracts to acquire real estate (perhaps off the plan) some time in advance and the borrowing arrangements have not been sufficiently advanced by the cut-off date.

Incidentally, it seems reasonable to assume that instalment receipt arrangements which do not involve a borrowing for the purposes of SIS are unlikely to be affected by any new constraints.

ATO’s view on non-arm’s length arrangements

In December 2014 the ATO released two interpretative decisions – IDs 2014/39 and 40 – each of which dealt with the question of whether a particular related party LRBA generated non-arm’s length income (NALI), which is taxed at 47% in the hands of the relevant SMSF. Each LRBA involved payment of interest at a rate lower than the rate which would apply if the lender had been a commercial provider. In both cases the ATO concluded that the income derived from the investment was NALI as it was greater than it would have been had the parties been dealing with each other at arm’s length. Each arrangement involved a number of characteristics which might be said to have been non-commercial. The ATO did not indicate the extent to which any particular feature contributed to its conclusion.

In the absence of further guidance from the ATO, it would seem that clients entering a related party LRBA need to align its terms as far as possible with those of a commercial arrangement. Unfortunately, it won’t always be obvious that an arrangement meets the commerciality benchmarks that need to be met to avoid adverse tax treatment. In particular, it may not always be clear what level of security a bank may require in a particular situation and how that might affect the interest rate charged. For example, would a bank seek a personal guarantee? If so, does it make commercial sense for someone to provide the guarantee? In some cases, therefore, it may be appropriate to apply for a private binding ruling.

ATO’s view on cross insurance arrangements

An SMSF with a sizeable LRBA for a geared asset may need to address the risk of having insufficient liquidity to repay the loan or pay out cash benefits on the death or disability of one of the members. One solution which has been widely canvassed is for the governing rules of an SMSF to provide that the proceeds of insurance on the life of one member will be payable to the other member’s (or members’) account(s) if the insured event occurs. That is, unlike typical super insurance arrangements, under this solution insurance proceeds aren’t paid out as an additional benefit for the disabled/deceased member, rather they provide fund liquidity and potentially remove the need for the geared asset to be sold.

The idea that Member B’s account can be credited with the proceeds of insurance over Member A is consistent with an approach which treats the insurance arrangement much like any SMSF investment: the premiums represent investments and the proceeds represent a return on investments. The premiums are deducted from Member B’s account and any relevant proceeds are credited to it. The minutes of the December 2012 National Tax Liaison Group (NTLG) Superannuation Technical Sub-group meeting did seem to indicate that the ATO was comfortable with such an approach.

However, at that stage the ATO had not considered the impact of a relatively new insurance-related operating standard in SIS. That standard provides that, from 1 July 2014, insured events covered under insurance policies taken out by super funds in relation to members must be consistent with the super law conditions of release for death, terminal medical condition, permanent incapacity and temporary incapacity. The ATO has recently turned its attention to that standard and concluded (in a seemingly unheralded statement on its website) that “cross insurance arrangements are not permitted where the proceeds of an insurance policy are paid to someone other than the insured under the policy are not permitted”, citing a comment in the Explanatory Memorandum which accompanied introduction of the standard as the basis for its view.

While professionals are likely to seek a more fulsome explanation of the ATO’s view on the subject, for the time being cross-insurance does not appear to be an acceptable solution to the LRBA liquidity issue outlined above. If the ATO maintains its current position there may be lobbying to amend the law so that it clearly allows cross insurance to support LRBAs, but success may be difficult given the current policy climate.

Removing a layer of taxation

On a positive note, in January 2015 the Government released draft legislation to provide “look through” income tax treatment for LRBAs and super and non-super instalment warrants and instalment receipts. This measure was originally proposed in March 2010. In practice the ATO already generally ignores the security trustee of LRBAs for income tax purposes, but under the current law there has been doubt about whether it should in many cases. Essentially, for an LRBA, if enacted the provisions would treat:

  • the SMSF trustee as the owner of the geared asset rather than the security trustee and
  • acts done by the security trustee as having been done by the SMSF trustee.

This would avoid a double up of CGT events and ensure that income derived from the geared asset would be attributed directly to the SMSF trustee who could offset all relevant deductible expenses and franking credits. If enacted the provisions would apply from the 2007-8 year onwards for all compliant LRBAs (including those which were established under the now repealed section 67(4A) of SIS).


It may be timely for SMSF clients with LRBAs to review their position with regard to future compliance taking into account recent developments. Those contemplating entering an LRBA also need to consider the possibility of future legislative constraints and the timing and associated risks.

Share this

If you enjoyed reading this article, why not share it?

Simply copy and paste the text and include a link to the article. Please read the Expertise Articles Terms of Use before sharing.

Related articles


Subscribe to our monthly newsletter

We bring you technical updates, financial insights and industry expertise.

Newsletter shown on desktop, ipad and mobile
Thank you for subscribing.
There seems to be an error with your request, please contact us.

Simply fill out your details below:

The information you provide on this form will be retained and handled by Macquarie in accordance with our Privacy Policy and we may contact you about products or services we feel may be of interest to you. If you do not wish to provide all details or receive information of this nature, please phone us on 13 62 96.

Find out how we can help

If you'd like to speak to a specialist about how we can help build your business, get in touch.

Any information on this page in relation to mortgages has been prepared by Macquarie Securitisation Limited (MSL) Australian Credit Licence (ACL) 237863 ACN 003 297 336.

Unless stated otherwise, this information has been prepared by Macquarie Bank Limited ABN 46 008 583 542 AFSL and Australian Credit Licence 237502.

This information is provided for the use of licensed and accredited brokers and financial advisers only. In no circumstances is it to be used by a potential client for the purposes of making a decision about a financial product or class of products.

Macquarie Investment Management Limited (MIML) ABN 66 002 867 003 AFSL 237 492 is not an authorised deposit-taking institution for the purposes of the Banking Act (Cth) 1959, and MIML’s obligations do not represent deposits or other liabilities of Macquarie Bank Limited ABN 46 008 583 542.  Macquarie Bank Limited does not guarantee or otherwise provide assurance in respect of the obligations of MIML.

The information provided is not personal advice. It does not take into account the investment objectives, financial situation or needs of any particular investor and should not be relied upon as advice.  Any examples are illustrations only and any similarities to any readers’ circumstances are purely coincidental. 

While the information provided here is given in good faith and is believed to be accurate and reliable as at 2 March 2015, it is provided by MIML for information only.  We will not be liable for any losses arising from reliance on this information.

MIML and Macquarie Bank Limited do not give, nor purport to give, any taxation advice. The application of taxation laws to each client depends on that client’s individual circumstances.  Accordingly, clients should seek independent professional advice on taxation implications before making any decisions about a financial product or class of products.

Copyright 2015 Macquarie Investment Management Limited ABN 66 002 867 003

Except for Macquarie Bank Limited ABN 46 008 583 542 AFSL and Australian Credit Licence 237502 (MBL), any Macquarie entity referred to on this page is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Cth). That entity’s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that entity, unless noted otherwise.

Important Information

Restricted to financial services professionals

This information on this website is provided for the use of financial services professionals only. In no circumstances is it to be used by a potential investor for the purposes of making a decision about a financial product or class of products.

In order to proceed, please confirm that you are a financial services professional by clicking 'I accept'.