Super Necessities: Limited recourse borrowing arrangements by SMSF
If you have a self managed superannuation fund (SMSF) you may have heard about limited recourse borrowings. This is not for everyone but in certain situations can be a very effective planning option and may provide your fund with much greater flexibility than was previously available.
What is limited recourse borrowing?
Historically superannuation funds have been able to borrow limited amounts, for limited purposes and for limited timeframes (e.g., up to 90 days in order to pay out a beneficiary).
Super law that applied from 24 September 2007 extended the borrowing capability of a superannuation fund to invest in some instalment warrants or enter into similarly structured and complying arrangements involving borrowing money to acquire a permitted asset.
How does a limited recourse borrowing arrangement work?
The diagram below shows the relationships in limited resource borrowing.
Under the limited recourse borrowing arrangement, an SMSF:
- makes an initial upfront payment of part only of the purchase price of an asset;
- borrows the balance of the purchase price from a lender; and
- progressively repays the borrowing (plus interest) through instalments until the asset is paid for in full.
For the period of the loan, the SMSF obtains an interest in the underlying asset and is entitled to all income from the asset.
The lender is entitled to interest on the loan and is protected by security over the asset being acquired through the arrangement. If the SMSF defaults on the borrowing, then the lender may have recourse to the underlying asset only - that is, the lender will have no recourse to any of the SMSFs other assets.
Tips for the Trustees
- Trustees should always consider the quality of the investment to ensure their fund can meet all of the future obligations under the arrangement.
- An SMSF trustee can only enter into such an arrangement where this is consistent with the fund;s investment strategy.
- The governing rules of the fund must allow the trustee to borrow before this arrangement can be entered into.
- The super laws have recently been amended with new rules applying to the limited recourse borrowing arrangements from 7 July 2010.
Contact us for more information and to ascertain whether we can assist you in relation to the establishment and/or maintenance of a SMSF as part of your overall financial planning.