The ATO has today issued draft SMSF ruling 2011/D1 which explains key concepts relevant to the application of the limited recourse borrowing arrangement (LRBA) provisions.
The draft ruling provides the ATO’s preliminary view on what constitutes a single acquirable asset and also provides further clarity on the distinction between a repair and an improvement in the context of a LRBA.
SPAA welcomes the ATO’s commonsense approach to the interpretation of these rules which in our view will greatly assist SMSF trustees and their advisers to plan with confidence.
Importantly, the ATO has relaxed their interpretation of what constitutes a “single acquirable asset” and will allow assets to be improved as long as the improvement does not fundamentally change the character of the asset and is not funded by borrowings.
Previously, the ATO’s view was that borrowed funds under a LRBA put in place on or after 7 July 2010, could only be used to obtain a single acquirable asset such as a property on a single title. This meant that a property covering more than one title required a separate LRBA for each title.
However, the draft ruling takes a different approach and recognises that a property that exists on multiple titles can still satisfy the definition of a single acquirable asset as long its physical characteristics identify it as a single asset and the titles are not able to be dealt with or sold separately.
The draft ruling also reverses the ATO’s previous view that an asset acquired under a LRBA entered into on or after 7 July 2010 could not be improved using funds from any source.
The draft ruling states that the property can be improved using the SMSF’s cash reserves or funds from another source as long as the improvement does not result in the acquirable asset becoming a new asset. For example, insurance proceeds could be used to rebuild an acquirable asset destroyed by fire or flood as long as the new asset has the same fundamental character as the asset it is replacing. However, borrowings under a LRBA cannot be used to improve the asset but can be used to repair or maintain the acquirable asset.
The ATO has made it clear in the draft ruling that they have no intention of being overly pedantic when it comes to the distinction between a repair and an improvement. Minor or trifling increases in functional efficiency or value as compared with the acquirable asset as a whole will not amount to an improvement.
Although the analysis and examples provided in the draft ruling focus primarily on real property, the principles discussed can also be applied to other types of assets.
When the final ruling is issued, it is proposed to apply to arrangements entered into on or after 7 July 2010 (including an arrangement that is a refinancing of a borrowing of money under an arrangement entered into before, on or after 7 July 2010).