A SMSF can borrow from the following sources to purchase properties or other assets:
- Most of banks in Australia like Commonwealth Bank, NAB, Westpac, ANZ, Macquarie, St George, Bankwest and some credit unions are actively involved in SMSF lending on limited recourse basis. If you do enough research and compare the rates and fees, you should be able to find a loan package that best suits you needs.
- Any related parties, like a member of the SMSF or relatives of the member can lend to the SMSF. The SMSF pays interest to the related parties. Therefore you can lend to your SMSF by drawing the equity in your home loan or other available funds.
- Any unrelated parties can lend to the SMSF.
The legislation does not prohibit on who can lend to the SMSF, so it is really up to the trustees to decide how finance the purchase of the property or the other assets in the SMSF.
Requirements for the SMSF loan to be complying
For the loan to be complying, the SMSF trustees need to ensure the borrowing structure is compliant by taking into consideration SISA and other tax rules:
- The loan must be a limited recourse loan between the lender and the SMSF
- A custodian/bare trust with a corporate trustee has to be set up correctly. The corporate trustee for the bare trust must be the registered owner of the property or other assets.
- A commercial loan agreement need to be formally executed if the borrowing is from a related party
Concerns from ATO
ATO’s concern about the SMSF borrowing should be noted:
- Sole purpose test may fail if all members are in pension phases
- The fund borrow to construct, develop or refurbish the property, which is not allowed in this borrowing arrangement
- The interest rate is not on a commercial basis for the borrowing from related parties.
- Asset to be purchased are not allowed by the law
- What is limited recourse borrowing? A limited recourse borrowing arrangement requires an SMSF trustee to take out a loan from a third party lender. The trustee then uses the loaned funds to purchase a single asset (or collection of identical assets that have the same market value) to be held in a separate trust.
Any investment returns earned from the asset go to the SMSF trustee.
If the loan defaults, the lender’s rights are limited to the asset held in the separate trust.
- Does interest on a borrowing from a related party need to be at commercial rates? A trustee of an SMSF or its investment manager must ensure that all investments are conducted on an arm’s length basis or, if the parties are not at arm’s length, that the terms of the investment are no more favourable to the other party than they would be if the parties were dealing at arm’s length.
- Can a related party borrow on a full recourse basis and on-lend the money to the SMSF under a limited recourse borrowing arrangement at a higher rate of interest? Yes but proper documentation and an arm’s length rate of interest required
- Does an arrangement that permits capitalisation of interest or other borrowing charges satisfy the super laws? Yes. The super law (specifically, subparagraph 67A(1)(a)(i) of the SISA) applying to these arrangements explicitly provides that, under a limited recourse borrowing arrangement, the SMSF trustee can apply borrowed money towards expenses incurred in connection with the borrowing.
- Can an SMSF member provide a personal guarantee to the lender in a limited recourse borrowing arrangement? Yes. The recourse of the lender against the SMSF trustees in the event of a default on the borrowing must be limited to the asset that is being acquired under the arrangement. A third party may put up their own assets as a guarantee to provide additional security to the lender.
- Can an SMSF trustee acquire more than one real property title under a single limited recourse borrowing arrangement? Multiple real property titles cannot generally be acquired under a single limited recourse borrowing arrangement.
- Can an SMSF trustee borrow under a limited recourse borrowing arrangement to build a house on vacant land owned by the fund?
No. An existing SMSF asset cannot be put into a limited recourse borrowing arrangement. The giving of a charge over an existing asset of the fund (the vacant land), as would generally occur under such arrangements, would contravene the super law.
Further reading – ATO publications on SMSF borrowing
- SMSFR 2009/2: the definition of SMSF borrowing
- ID2010/162: borrowing from a related party
- ID2010/169: SMSF borrowing and refinancing
- ID2010/170: SMSF borrowing and guarantees
- ID 2010/172: SMSF joint borrowing
- ID2010/184 : SMSF borrowing interest capitalisation
- ID 2010/185 : SMSF borrowing charge
- SMSFR 2012/1: Key concepts of borrowing
- TA 2012/7: Certain arrangements do not comply with SISA