When is a Repair not a Repair? New Ruling for SMSF Held Assets
by Michael Williams, Managing Director and Senior Financial Adviser
It has always been a matter of contention whether a superannuation fund could make ’repairs’ or ‘improvements’ to a property acquired under a borrowing arrangement.
So it was a welcoming announcement from the ATO which has now clarified a number of grey areas in this regard. The Commissioner has released what they have called Draft Ruling SMSFR 2011/D1, which details the specific regulations of Limited Recourse Borrowing Arrangements and, refreshingly, it takes into account both commercial realities and market opinions.
The Commissioner set to clarify three main points in the Draft Ruling, which were:
• Definition of a ‘single acquirable asset’
• What constitutes 'maintaining' or ‘repairing’ an asset, versus an ‘improvement’ to an asset
• When is an asset a prohibited replacement asset
Generally speaking, it has been our belief the ATO has a preference for investors to hold long term passive investments. This recent Draft Ruling follows that preference, with the Commissioner clearly opposed to property development within the superannuation environment. The original legislation was sought to discourage such development within superannuation funds, however in doing so, unintendedly created a blurring of the lines between what is deemed as a ‘repair’ to a property, and what is deemed as an ‘improvement’. Such confusion complicated things for investors who were simply wishing to hold their property as a long term investment.
Single Acquirable Asset
It has always been the advice of our solicitors in the past that where two assets were intrinsically linked, and could not be dealt with separately, then can be deemed then as one single asset. The two common occurrences of two linked assets being recognised as one single asset are:
• When a property has been constructed across two or more certificates of title
• When certificates of title cannot be dealt with separately, for example if a real property and its accompanying car park are on separate titles
When is an Asset not a Single Acquirable Asset?
The Commissioner’s view is where assets can be dealt with separately and are not intrinsically linked, they will not constitute a single acquirable asset. For example, if a Vendor wants to sell a 10 acre block which consists of 2 titles, they will be recognised as two assets for the purpose of limited recourse borrowing rule, therefore it’s not a single acquirable asset. However, if there was as building on the 10 acres which was positioned across both titles, then the two assets would be intrinsically linked, and therefore it would be recognised as a single acquirable asset.
Difference between ‘Repair,’ ‘Maintenance’ and ‘Improvement’
The ATO has furthermore set to clarify what constitutes as ‘maintenance’ and ‘repair’ of a property, and what is classed as an ‘improvement’. The Draft Ruling allows for draw downs to occur within superannuation funds if the Trustee is doing so for the purpose of ‘maintaining’ or ‘repairing’ their asset, however if it’s for the purpose of ‘improving’ the asset, then this will be a breach of regulation.
In the Commissioners view, when referring to an asset held under a limited recourse borrowing arrangement, the following definitions apply:
Maintenance: prevention of damage, defects or deterioration of an asset for the purpose of ensuring its ‘functional efficiency’.
Repairing: restoration or repair of the ‘function efficiency’ of an asset, without changing its character. Repairs can be items such as:
- Replacing a damaged kitchen with a new kitchen
- Painting the exterior of a house
- Resurfacing a swimming pool
Improvements: improving an asset to the extent that it transforms the existing asset into a different asset, for example:
- Adding a swimming pool
- Adding a set of cattle yards
- Adding a second storey to a single story residence
In terms of the new ruling, it’s been stated that a Trustee cannot use borrowed funds to make ‘improvements’ to an asset, because making ‘improvements’ would change the asset to such an degree that it’s created an entirely new asset; for example, if you add a swimming pool to a property, the assets has changed to such a degree that it’s deemed as a new asset.
In terms of repairs, it’s worth noting that you can still ‘repair’ your kitchen, for example, by replacing damaged cheaper tiles with nicer ceramic tiles, as you are simply using more modernised materials to repair your asset, and the increase of cost does not automatically deem it an ‘improvement.’
What Does this Mean for SMSF Investors?
In short, the more clearly defined ruling is good news for those Trustees left wondering what their right and obligations were under borrowing arrangements within their Superannuation. It’s good news for all those questionable repairs you may have been thinking of doing, but bad news for would-be property developers who were planning on making substantial changes to their asset.
The Draft Ruling goes into great detail on what constitutes as what when it comes to making alterations to an asset through your Superannuation, to the extent of giving various detailed examples. So, it’s worth contacting your Financial Adviser for more information if you’re planning on making any physical changes to your asset held within your Superannuation.
To review the Draft Ruling SMSFR 2011/D1 in its entirety, click here.
We can explain this ruling in more detail in person, should you wish to discuss the technical aspects of this new regulation and how it will affect you personally. For further information, call our office on 1300 726 082 to make an appointment with a John Hopkins Financial Adviser.