The Financial System Inquiry (FSI) has come up with its Interim Report and it categorically states the increasing penchant of SMSF holders towards borrowing. The Sole Purpose Test unequivocally suggests that the main idea behind SMSFs is to bolster retirement fund. Any other use must be limited and kept at the periphery and hence the concern.
SMSFs allow members to borrow against them, leading to some serious investment in the real estate sector. The borrowings are subject to Limited Recourse Borrowing Arrangement (LRBA). Negligent use of the facility and tendency towards non-compliance (for one reason or other) has been a bane at large and this is exactly why the SPAA has come up with certain guidelines. SMSF borrowing is okay till you tread within the ropes. Let us find out more.
The loan is limited recourse and this implies that there is no cross-collateralisation available to the lenders. If the loan is secured via a particular asset in the fund and the borrower (SMSF member) defaults on interest payment, the lender is only eligible to attach that asset and not the other assets in the fund.
Obviously, the fund has the right to repurchase the asset after the loan has been squared off. Also, the SMSF borrowings assert that the single acquirable asset must be bought at a time.
Excessive negative gearing
SPAA is also averse to excessive negative gearing. Seeking capital growth is a noteworthy pursuit, but jeopardising positive cash flow and stifling chances of timely repayments are not what the SPAA asks you to do if you use SMSF for the borrowing purpose.
So, investors having a gigantic portfolio are more than welcome to go after negative gearing to their heart’s content, but they should and must observe cash flow to some extent for those properties brought through SMSF.
It goes without saying that the postulates of arm’s length transactions and related party lending must be observed inasmuch as possible.