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LRBA life events


During the life cycle of a limited recourse borrowing arrangement (LRBA) held by an SMSF, there will be events that will require consideration of how they will affect superannuation compliance and income tax issues. In this article we consider these events and their consequences.

Year end LRBA asset value less than outstanding loan amount

There may be times where the market value of the asset under the LRBA is less than the outstanding loan balance. This presents the question of disclosure in the SMSF’s financial statements of the value of the asset and the related loan. There will also be consideration of the compliance requirement of SIS regulation 8.02B to disclose SMSF assets in the annual financial statements at ‘market value’.
Disclosing the asset under the LRBA at market value and the outstanding balance of the loan would result in a negative asset amount. However, an LRBA related loan is required to be a non-recourse loan, that is, the lender only has rights to the asset under the loan. From the SMSF’s perspective as the borrower, this means only the value of the asset under the LRBA is at risk to the lender. So, what’s the disclosure approach?

Let’s consider the following scenario:

The UBute Super Fund, an SMSF, acquired a commercial property using an LRBA with a loan from an arm’s length commercial lender. At 30 June 2022, the value of the property and the outstanding loan amount is as follows:

  • Property market value: $650k
  • Outstanding loan amount: $690k

SIS regulation 8.02B requires the property to be disclosed in the annual financial statements at market value. Consequently, the market value of $650k will be the amount used.

However, the loan is not an asset and not subject to SIS regulation 8.02B. Given the loan is on a non-recourse basis and the lender will effectively only be able to recover from the fund the value the asset realises (effect of a call on personal guarantees considered below), the disclosed amount of the loan owing could be reduced to equal the market value of the property, given a net asset value of the LRBA of zero. The financial statements should include an appropriate note which would include the actual outstanding loan balance together with an explanation that the disclosed amount has been reduced to the value of the asset under the LRBA due to the non-recourse nature of the loan.

Call on personal guarantee

Whilst a loan under an LRBA must be on a non-recourse basis, arrangements entered into from 7 July 2010 allow for an SMSF member to provide a personal guarantee to a lender. However, the guarantors rights against the SMSF borrower must be limited to rights relating to the asset acquired under the LRBA. Effectively, this means that both the lender and the provider of the personal guarantee can only recover from the asset under the LRBA.

A personal guarantee provides a lender with a mechanism to recover any shortfall in the event the proceeds realised from the sale of the asset under the LRBA is not sufficient to pay out the loan in full. Whilst the lender cannot recover any shortfall from the SMSF borrower, it can call upon the personal guarantee to meet the shortfall.

Where a lender calls on the personal guarantee, the amount paid by the guarantor my be treated as a contribution. However, this will depend on the circumstances that caused the guarantor to make the payment. The ATO notes the following two circumstances that give rise to different contribution outcomes:

  1. If a guarantor makes a payment to the lender under an arrangement where they have foregone their usual rights of indemnity against the principal debtor (the SMSF trustee) for the guarantee, this is a contribution to the SMSF if it satisfies a liability of the SMSF. This might happen, for example, if the guarantor paid the borrowing and the acquirable asset was transferred to the SMSF trustee under the arrangement.
  2. In contrast, there is no contribution if the SMSF trustee has exercised a right to walk away from the arrangement (and has lost the acquirable asset to the lender) and has no further liability, but the lender still exercises a right to call on the guarantee for a shortfall after disposal of the original asset.

In essence, where the SMSF retains the asset due to payment by the guarantor, the amount paid by the guarantor will be regarded as a contribution. Allocation of the contribution amongst SMSF members and whether it is treated as a concessional or non-concessional contribution may depend upon whether:

  • the guarantor is also a member of the SMSF; and
  • the asset under the LRBA was segregated, either for tax and/or investment purposes.

Forgiveness of LRBA loan by a commercial lender

Where an SMSF sells an asset under the LRBA and the proceeds do not cover the outstanding amount of the loan, forgiveness of the outstanding loan balance by the lender may be subject to the commercial debt forgiveness rules in Division 245 ITAA 1997.

The rules operate such that when a lender forgives a commercial debt owed by the borrower, the borrower makes a gain. However, this is usually not included in the borrower’s assessable income, instead, the forgiven amount is offset against amounts that could otherwise reduce the borrower’s taxable income in the same or a later income year. Those amounts are:

  1. the borrower’s tax losses and net capital losses; and
  2. capital allowances and some similar deductions; and
  3. the cost bases of the taxpayer’s CGT assets.

Generally, the value of the debt forgiven will be the amount owing at the time of the forgiveness by the lender. The amount of the debt forgiveness would be offset in the order outlined above. Assuming the SMSF has no brought forward income tax or capital losses, the amount forgiven would reduce the cost base of the asset that was held under the LRBA, effectively reducing the capital loss on sale. If the property was sold in the prior year and the debt forgiven in the subsequent year, the value of the debt forgiven would reduce the brought forward capital loss.

Example

The Cast-a-way Super Fund acquired a property under an LRBA. The cost of the property was $755,250. The property was recently sold for $350,000 and the loan outstanding at the time was $425,250. After applying the proceeds, the commercial lender forgave the outstanding balance of $75,250.

Applying the commercial debt forgiveness rules, the capital loss outcome is as follows:

Consideration $350,000
Less: cost base$755,250
Capital loss$405,250
Reduce loss by debt forgiveness amount$75,250
Reduced capital loss$330,000

Where the loan was from a related party lender, a forgiveness of an amount of the loan would generally be regarded as a contribution. Refer to TR 2010/1.

Loan repayment

Once the loan has been repaid, the SMSF trustee(s) will have the following considerations:

  • Ensuring the mortgage is fully discharged, that is, the charge over the LRBA asset secured by the lender has been removed. The exception to the prohibition to allowing a charge over an asset for an LRBA no longer applies as the loan has been repaid;
  • Whether to transfer the legal title of the asset held under the LRBA to the SMSF trustee(s). The LRBA rules require the SMSF trustee(s) to have a right to acquire legal ownership of the asset held under the LRBA, however, there is no requirement for legal ownership to be transferred. Where the legal title to the asset is not transferred to the SMSF trustee(s), the funds investment in the related trust will continue to be exempt from being treated as an in-house asset under section 71(1)(f) SIS Act pursuant to an ATO legislative instrument, SPR 2014/1, “Self-Managed Superannuation Funds (Limited Recourse Borrowing Arrangements – In-house Exclusion) Determination 2014”.

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