Green light for LRBAs

Limited recourse borrowing arrangements (LRBAs) have been greenlit by a recent enquiry, and also comments from the Assistant Treasurer.  

The Council of Financial Regulators in November released its second report on Leverage and risk in the superannuation system. Consistent with the 2019 report, the Council found that LRBAs are “unlikely to pose a material risk to the superannuation system or broader financial system”. Following this, in the lead up to the recent Federal Budget, the Assistant Treasurer Steven Jones confirmed that there are no current plans to ban such arrangements.

This comes as somewhat of a relief to investors as LRBAs have been under threat in recent times with the former government flagging a complete ban on these products as far back as 2016, and the Labor party also proposing a ban as part of its suite of policies it took to the 2019 election. 

For background, trustees of self-managed super funds (SMSFs) are generally prohibited from borrowing money, subject to limited exceptions under the super law. One of these exceptions is for LRBAs which involve an SMSF trustee taking out a loan from a third-party lender. The trustee then uses those borrowed funds to purchase a single asset such as shares or property (or collection of identical assets that have the same market value) to be held in a separate trust.

Any investment returns earned from the newly-acquired asset go to the SMSF trustee. If the loan defaults, the lender’s rights are limited to the asset held in the separate trust. This means there is no recourse to the other assets held in the SMSF.

While LRBAs can be used to purchase any permitted asset, this structure is particularly attractive to those who wish to enter into property investment as part of their fund’s investment strategy. Business owners may even wish to acquire business premises using an LRBA. 

The advantages of an LRBA include:

• That they enable your SMSF to acquire big-ticket assets with a potential for significant growth that it may not otherwise have the capacity to acquire without borrowing
• Investment diversification
• Investment earnings and capital gains inside superannuation are taxed at concessional rates.

On the flipside there are certain risks involved:

• As with all gearing, the profitability of this strategy depends on the income and capital growth of the proposed investment being greater than the borrowing and ongoing costs
• Potential illiquidity risk – if the asset acquired is a major portion of the SMSF’s total assets and the asset cannot be sold quickly, it may impact on the SMSF’s ability to meet its payment obligations to members.

Be mindful that the lender is not likely to allow you to borrow the full amount for the investment. Many lenders will only lend 50% to 60% (though some may go as high as 80%), so this will mean that you need existing funds in your SMSF to pay for the deposit.

In this space, it’s important to seek professional advice before acting. Feel free to contact us for further guidance.