![The government's proposed change comes from suggestions people are using loans to rort the transfer balance cap.](/content/dam/images/g/w/3/0/w/7/image.related.afrArticleLead.620x350.gw2x29.png/1494551604042.jpg)
A government proposal to add outstanding loan amounts to the superannuation balances of self-managed funds with limited recourse borrowing arrangements (LRBAs) may not be as dramatic a measure as first thought.
For a start, it appears this applies only to new loans after July 1. This will be a relief to those in accumulation phase with existing loans who were concerned about making debt repayments if breaching the $1.6 million cap left them unable to make non-concessional (after-tax) contributions. Repayments for these loans have to be paid from super fund money and can't be funded from outside super.
Second, not many in pension phase are likely to be affected because in most cases borrowings are paid off well before retirement. If not and in instances where the borrowing pushes someone over the $1.6 million transfer balance cap, any excess would have to be transferred back to accumulation phase.
The budget's reform measure proposes a requirement that SMSFs with LRBAs include the outstanding loan balance in a member's annual total superannuation balance.
Among the potential repercussions is a restriction on non-concessional contributions where a portion of the loan amount takes a member's super balance above $1.6 million. Another restriction will limit the scope for SMSFs to use proposed catch-up concessional (pre-tax) contributions where a loan portion increases their super balance beyond $500,000.
If a fund happens to be one of a minority that has an LRBA when it moves into pension mode, super advisers reckon the investment can be managed in such a way that it doesn't fall foul of the proposed rules that will see outstanding loan amounts added to fund balances.
Unusual cases
Bryce Figot, a special counsel with DBA Lawyers, says the legislation being proposed by the government is based on a way of managing a property that is not the standard way of running an investment under a limited recourse borrowing arrangement.
In fact, scenarios in the draft legislation that illustrate circumstances where the outstanding loan balance of an LRBA is likely to be added to the superannuation balance of an SMSF are quite unusual. Arguably they might even suggest a fund has engaged in an activity that could actually be considered illegal under current super rules.
According to SMSF specialist adviser Lyn Formica of McPhersons Super Consulting, a problem with the draft legislation is that not all of it makes sense when it comes to explaining why the reforms are being introduced.
Only a month ago when revenue and financial services minister Kelly O'Dwyer foreshadowed the LRBA reform proposal as a measure that arose from government concerns about SMSFs using borrowing arrangements to get around contribution rules, there were already super specialists suggesting they hadn't come across anyone employing strategies along the lines being outlined as the reasons for the potentially game-changing LRBA reforms.
These strategies claim people could use LRBAs to rort the government's proposed transfer balance cap that from July 1 will limit tax-free pension accounts to $1.6 million. How they might do this is by organising to pay off loans on property investments held in a fund's pension account from money in accumulation accounts.
Integrity measure
Whether this can actually be done in the manner described in the draft LRBA legislation is debatable, say some advisers, given long-standing superannuation regulations that require fund costs to be allocated in a way that is reasonable and not manipulated as the government legislation would appear to suggest.
That the LRBA proposal may not be as dramatic a measure as initially thought was also suggested in a reference to the proposed reform in this week's federal budget. What was interesting about the budget reference where it was described as an integrity measure, said financial planner Nerida Cole, of Dixon Advisory, was an expectation it would raise only $4 million over the next four financial years. This suggested it was an issue that people shouldn't be too alarmed about. It also suggested the LRBA proposal could be legislative overkill by government.
This could be due to only relatively few SMSFs having borrowing arrangements in place once members had moved to the pension phase.
Most people who have LRBAs are in the accumulation phase with some years before they enter retirement and begin a pension. While there may be a few exceptions to this, most people prefer not to have debt in retirement, says Cole.
Whether it's in their personal name or in their super fund, it makes sense to be clear of debt before retirement. It can be harder to make repayments when there is a greater need for generating income for retirement.
An LRBA, says Cole, is a strategy that works best where someone has a good seven to 10 years before they retire. This is more likely to be a period of time where they have strong cash flow outside super that allows them to make contributions to help manage debt repayments. It is also a time when contributions can be employed to help establish a diversified portfolio rather than one with all its eggs in a property basket.
Very complicated
That the LRBA proposals are very complicated is without doubt prompting some experts to question whether they can be implemented in the way the government is proposing.
Others who have examined the legislation think the major and quite radical changes to LRBA rules will make borrowing to invest in super more complicated for those who might carry a borrowing strategy into the pension phase. Colin Lewis, senior manager of strategic advice with Perpetual Private, says it doesn't make a lot of sense to have an LRBA in the retirement phase. He would generally never recommend it.
That said, according to the budget reference, any changes will apply only to loans entered into after (and if) the legislation becomes law, after July 1.
Existing LRBAs and any new LRBAs entered into between now and when this happens should not be affected. The same goes for any LRBAs that are refinanced during this period.
But an absence of any grandfathering provisions in the draft legislation suggests that refinancing a LRBA loan after the change becomes law will likely bring an existing borrowing arrangement into the new rules, says Formica.
Any comments to John.Wasiliev@fairfaxmedia.com.au
AFR Contributor