The most evil thing in the world

The debate over the ability of SMSFs to use limited recourse borrowing arrangements (LRBA) seems to have gained momentum recently, with a ban on these facilities once again being suggested by some parts of the industry.

The topic might be attracting a lot of attention right now because the Council of Financial Regulators (CFR), a body that has been monitoring the use of LRBAs, is due to report back to the government at the end of the year.

This body is chaired by the Reserve Bank of Australia, with its members being the Australian Prudential Regulation Authority, Australian Securities and Investments Commission (ASIC) and Treasury, and was established in response to the Financial System Inquiry’s recommendation to ban LRBAs back in 2014.

Most interestingly before the CFR has even completed its work on this subject, ASIC has already told the Parliamentary Joint Committee on Corporations and Financial Services it is in favour of banning LRBAs outright. Perhaps this is a warning as to what is about the happen.

From some of the hysteria surrounding the debate anyone would have thought these lending instruments were the most evil thing ever created.

They have been cited as the reason why the SMSF establishment rate has been so high, the reasoning being so many people have set up an SMSF just to be able to acquire a residential property via an LRBA in the fund.

From this conclusion, LRBAs have also been identified as a significant contributing factor to the housing affordability problem in this country as all of the SMSFs are being able to buy too much residential property in Australia through the use of gearing.

This is of course quite far from the truth as ATO statistics indicate at 30 June 2016 SMSFs using LRBAs to purchase residential property only contributed $12 billion to the $6.05 trillion housing market. That represents 0.2 per cent.

Further, because of the LRBA effect on the rise in SMSF establishments, these gearing instruments are also encouraging a raft of people to run their own super fund when it’s not appropriate for them to do so. While the issue of property spruikers promoting the set-up of SMSFs indiscriminately out of self-interest is real, I’m not sure we can say this practice is at plague proportions just yet.

The ATO statistics also showed at 30 June 2016 only 6.92 per cent of SMSFs had acquired assets under an LRBA, and only 5.97 per cent had used an LRBA to buy property.

What seems to be lost in this whole argument is that an LRBA can be a very effective way for acquiring business real property in an SMSF, for example, when a business owner purchases the business premises inside an SMSF. This can be a very powerful strategy allowing the individual to claim a tax deduction for the office or shop rent in the business while recognising the rental income in the SMSF and having it taxed at a lower rate.

But the end game may have already been decided regardless of ASIC’s attitude toward these instruments.

The tightening of the banking rules around capital adequacy on lending have potentially seen all of the major banking institutions withdraw their lending facilities for SMSFs.

This development alone may have scuppered the flawed reasoning behind the push to ban SMSFs. In a free market those activities that are most lucrative from a revenue and profit perspective will always survive. It stands to reason then LRBAs were not that profitable for the banks if they have been so ready to jettison these loans in the name of capital adequacy.

Out of all of this, can we conclude LRBAs have been the work of the devil or will something seen as unpopular in the non-SMSF world be effectively taken away, depriving many trustees the opportunity to employ a powerful asset-acquiring strategy?


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