Abolition of borrowing by SMSFs recommended following Financial System Inquiry
Under our current Superannuation laws, Self Managed Superannuation Funds (SMSFs) are able to borrow money to acquire fund assets if certain conditions are met. These borrowings are known as “limited recourse borrowing arrangements” (LRBAs) which, pursuant to Section 67A of the Superannuation Industry (Supervision) Act 1993 (SIS Act), are an exception to the general prohibition on direct borrowing by superannuation funds.
The recent Financial System Inquiry (FSI) chaired by former Commonwealth Bank CEO David Murray resulted in the release of The Murray Report on 7 December 2014 which made certain recommendations relating to superannuation. One of the recommendations is a prospective ban on direct borrowing by superannuation funds using LRBAs.
Why the recommendation for a ban on borrowing?
The Murray Report states the problem it seeks to address as ‘growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system.’
The Report noted a growing trend of superannuation funds using LRBAs to purchase assets. According to the ATO, the number of LRBAs has more than tripled from $2.5 billion at the end of June 2012 to $8.7 billion at the end of June 2014.
One of the key messages of the Report is that borrowing by superannuation funds is inconsistent with the objectives of superannuation; that is, to be a savings vehicle for retirement income rather than a wealth management vehicle.
It is quite possible that, for example, in the case of another global financial crisis, assets purchased with borrowings could decline in value, leading to forced sales which could result in substantial capital losses for the SMSF. This would be a threat to people’s retirement savings.
What do the recommendations mean in practice?
The Government is currently seeking industry and public feedback on the recommendations (due by 31 March 2015) and may not respond until the May 2015 Budget. The recommendations do not constitute law but as the inquiry was commissioned by the Government, it is likely the Government will consider some of the recommendations.
If the Government does accept the recommendations, the legislation to implement the changes will follow later. Trustees of SMSFs with existing LRBAs will be pleased to know that part of the recommendations is a grandfathering arrangement whereby funds with “existing borrowing” arrangements should be permitted to maintain them.
Obvioulsy SMSF Trustees wanting to engage in LRBAs should do so as soon as possible so that they have an “existing borrowing” in place, that is, a signed loan contract.
If you are an SMSF trustee wanting to borrow to acquire assets, or more importantly, if you have recently or will shortly sign purchase contracts to purchase a fund asset but have not signed loan contracts with your lender, you should not delay in doing so as you could get into strife if you are relying on borrowed funds to settle. Remember that just like any borrowing, a LRBA takes time to put in place.
For further information contact:
Rosemary Carreras, Senior Associate
Phone: +61 2 9635 6422