Update — SMSF pensions and limited recourse borrowing: they are compatible, but be careful

In our June 2011 ClearLaw article 'Pensions and limited recourse SMSF borrowing: are they compatible?', we considered a possible tension between:

• trustees using SMSF assets for limited recourse borrowing; and
• the prohibition on the use of the capital and income of pensions as security for borrowings.

Now we have received non-binding advice from the Australian Taxation Office confirming that the prohibition is intended only to stop a member from using their pension entitlement as security for borrowing. That said, trustees should remain aware of the prohibition as a SMSF engaged in both paying a pension and a limited recourse borrowing arrangement needs to carefully manage those arrangements to ensure the SMSF complies with the law.

Clarification from the ATO: the pension is an asset in the member's eyes

When an SMSF member chooses to receive his or her benefit as a pension, the SMSF trustee(s):

• must establish a pension account;
• may segregate assets of the SMSF; and
• may allocate the value of these assets to the pension account.

It is these assets that must not be used as security for any limited recourse borrowing.

Using the capital value of an SMSF pension and the income from it as security for a borrowing is prohibited by the regulations.[1] For the member, this capital value and income are an asset. In the ATO's view, it is for this reason that the prohibition against using the capital value of the pension and the income from it as security is intended to stop SMSF members from using their pension entitlement as security for borrowing.

From the perspective of the SMSF trustee(s), the capital value of the pension and the income from it are liabilities of the SMSF. The SMSF requires assets that are not used as security for limited recourse borrowing arrangements to discharge these liabilities. As a general rule, the trustee(s) are prohibited from allowing charges in relation to the assets of the SMSF,[2] unless otherwise authorised by the law.[3] One such authorisation is in the case of limited recourse borrowing arrangements.[4]

As part of those borrowing arrangements, SMSF trustee(s) are permitted to borrow money to acquire an asset as long that the asset is held on trust by a custodian so that the SMSF trustee(s) acquire a beneficial interest and have the right to acquire legal ownership by repaying the borrowing. The lender's rights are limited to the 'acquirable asset'. This asset must not be an asset that is allocated to the pension account.

Risks for trustees

SMSF trustee(s) should remain aware of the prohibition against using the capital value of the pension and the income from it as security for any limited recourse borrowing. As discussed in our previous article, if the trustee(s)propose to enter into a limited recourse borrowing arrangement, then they should ensure that any security provided is not over an asset (or liability, from their perspective) that comprises part of the 'capital value' of the pension being paid to any members of the SMSF.

What is the nature of the ATO's 'non-binding and general advice'?

Unlike an ATO ruling, the advice provided by the ATO in this respect is only general in nature and is not binding on the Commissioner of Taxation. Therefore, while the advice indicates the ATO's likely approach, the ATO is not bound by the advice. Furthermore, the advice given is only general and may not be relevant to every scenario. If you are concerned about the potential risks of a trustee administering both a pension and a limited recourse borrowing arrangement for the acquisition of an asset, then you should obtain legal advice.

More information from Maddocks

For questions or more information about the above article, please call Maddocks in Melbourne (03 9288 0555) and ask for a member of the Superannuation Team.

More Cleardocs information on SMSFs

You can read other articles concerning superannuation and SMSFs here.

Order SMSF related document packages

• Set up an SMSF
• Update an SMSF deed
• Set up an SMSF pension
• Arrange SMSF borrowing lending docs:
  • for when the lender is a bank
  • for when the lender is a related party
• Set up an SMSF corporate trustee
• SMSF Death Benefit Nomination - binding or non binding
• SMSF Death Benefit Agreement - binding and permanent

Download

Download a checklist of the information you need to order a document package.

[1] 1.06(2)(h) of the Superannuation Industry (Supervision) Regulations 1994 (SISR)

[2] Regulation 13.13 of the SISR

[3] Regulation 13.15 of the SISR

[4] Section 67A of the Superannuation Industry (Supervision) Act 1996