March 2015 Newsletter -Potential ban on direct borrowing for SMSFs

Potential ban on direct borrowing for SMSFs

Limited recourse borrowing is being investigated

Potential ban on direct borrowing for SMSFs

MSF's that wish to borrow to purchase a property will be able to continue to do so for now, but as the government assesses the recommendation of the Financial System Inquiry Final Report (released on 7 December 2014) to ban limited recourse borrowing arrangements (LRBAs) in SMSF's, the options to overhaul the strategy of limited-recourse borrowing to buy property are being investigated.

Whilst there is little evidence of abuse of LRBA's to date with just 2% of Australia's SMSF's employing this strategy, it was acknowledged by Assistant treasurer Josh Frydenberg at the SMSF Association's national conference in February 2015 that borrowing in superannuation is an "important and sensitive" issue for the SMSF sector, particularly if leverage in superannuation did grow to a level where it could be a threat to people's retirement saving.

The arguments put forward by the Inquiry to reinstate the prohibition on LRBA's in SMSFs included but were not limited to:


  1. Creates unnecessary risk for the financial and superannuation system.
  2. Does not fulfil the objective of a superfund, that is, to be primarily a savings vehicle for retirement and not a wealth management tool.
  3. Places the downside risk associated with LRBAs on the taxpayer who would have to then fund any losses through the Aged Pension.
  4. Creates concentration risk in the fund. It is commonplace that the inclusion of leveraged assets, like property, are likely to be the sole asset of a fund and will dilute other assets such as shares and cash.
  5. The requirement to provide personal guarantees as collateral for these LRBAs may see Trustees selling other assets of the fund - to fund losses - rather than to allow the personal guarantees to be called.



The Inquiry suggested that these issues could be avoided by creating rules on asset composition within a fund to ensure sufficient diversification, or by enforcing a ceiling on loan to value ratios for these LRBAs, to ensure that any decrease in the asset value would not create a loss within the fund.

Josh Frydenberg suggested that what could be banned was SMSF trustees giving lenders personal guarantees. According to SMSF Association senior policy manager Jordan George, personal guarantees encourage more risky behaviour by trustees, who are not as aware of the risks involved in geared property investing as they should be. 

The SMSF association did recommend that any potential changes to come should be forward looking rather than retrospective, with any existing loan arrangements being grandfathered. Additionally any changes to limited-recourse borrowing would want to cater for the complexities of SMSF's buying property off the plan and looking to set up an LRBA that won't be executed until settlement, which could be several months down the track.

 

Expect much discussion on gearing in super to continue into 2015, especially during the lead up to the Federal Budget on May 12.

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