Generally, borrowing money or maintaining an existing borrowing is prohibited in SMSFs to ensure compliance with the sole purpose test, providing retirement benefits to members or paying death benefits if a member dies before retirement. However, there are limited exceptions to this rule.
This article outlines the flexibility provided to trustees, focusing on Section 67 of the SIS Act and key exemptions.
SMSF Borrowing Rules: Definitions and Prohibitions (based on SMSFR 2009/2)
- Borrowing is an arrangement that includes:
- A temporary transfer of money from one entity (the lender) to another (the borrower)
- An obligation or intention on the part of the borrower to repay the amount to the lender (which may be satisfied by the provision of an asset)
- Money refers to any generally accepted medium of exchange for goods, services or debt payment that confers complete liquidity. This includes both Australian and foreign currency.
- Maintaining an existing borrowing occurs when a borrowing arrangement previously entered into remains in place and the SMSF trustee is obliged or intends to repay the money lent. This includes situations where the trustee has borrowed the money or has become liable under a borrowing arrangement entered into by another party.
- Examples of transactions or circumstances that are considered borrowing include:
- A loan of money, whether secured or unsecured
- A margin lending account once drawn upon
- A bank overdraft once drawn upon
- Examples of transactions or circumstances that are not considered borrowing include:
- Bona fide contributions to SMSFs accepted and dealt with under the Superannuation Industry (Supervision) Regulations 1994 (SISR)
- The liability of an SMSF to pay benefits to members as they fall due
- Arrangements where expenses are paid on behalf of the SMSF trustee by an agent or other person, with immediate reimbursement
- Normal commercial delays in the payment of expenses incurred by an SMSF trustee
Section 67: Exceptions and SMSF Borrowing Capacity
These exceptions provide trustees with limited flexibility in managing and growing fund assets.
- Temporary borrowing to fund a payment to a beneficiary or pay an advance instalment
- The payment must be required by law or by the trust deed of the fund
- The trustee must be unable to make the payment without borrowing
- The borrowing period must not exceed 90 days
- The total amount borrowed must not exceed 10% of the value of the fund’s assets
- Temporary borrowing to cover settlement of certain security transactions
- At the time the investment decision was made, it must have been unlikely that borrowing would be required
- The borrowing period must not exceed 7 calendar days; this is a strict limit and must be adhered to without exception
- The total amount borrowed must not exceed 10% of the value of the fund’s assets
- Limited Recourse Borrowing Arrangements (LRBAs)
- The money must be used to acquire a single acquirable asset (e.g., real property, listed shares, or listed units in a trust)
- The borrowing may also cover expenses related to the acquisition or maintenance of the asset, but not improvements
- The asset must be held in a separate trust arrangement, with the trustee acquiring the beneficial interest
- The trustee must have the right to acquire legal ownership of the asset by making one or more payments
- The lender’s rights must be limited to the acquirable asset in relation to the borrowing and any related charges
- If the trustee has other rights relating to the asset, the lender’s rights must still be limited to the asset
- The asset must not be subject to any charge other than that provided in relation to the borrowing
- Other Borrowings: Installment Warrants and Grandfathered Arrangements
- Prior to the introduction of LRBA rules in 2007, some SMSFs used installment warrant structures to invest in property or shares
- If still in place, these structures may be grandfathered and allowed to continue under transitional rules
Other Exceptions for SMSFs
Beyond borrowing exemptions, trustees enjoy additional flexibility in SMSF operations:
- SMSF Related Party Transactions
- SMSFs can lease business real property to a related party if:
- The arrangement is on arm’s length terms
- The property is used wholly and exclusively for business purposes
- SMSFs may invest in related non-geared trusts or companies under strict conditions outlined in SIS Regulation 13.22C
- SMSFs can lease business real property to a related party if:
- In-House Asset Rules (Section 71 of SIS Act)
- SMSFs must ensure that in-house assets do not exceed 5% of the market value of the fund’s total assets
- In-house assets include:
- Loans to a related party of the fund
- Investments in a related party of the fund
- Assets leased to a related party (e.g., business equipment or machinery)
- Acquisition of Assets from Related Parties (Section 66 of SIS Act)
- SMSFs cannot acquire assets from a related party unless:
- The price reflects market value
- The asset is:
- A listed security (e.g., shares, units, or bonds listed on an approved stock exchange)
- Business real property
- An asset specifically excluded from being an in-house asset
- SMSFs cannot acquire assets from a related party unless:
Practical Considerations When Using SMSF Borrowing Exemptions
While the SIS Act provides limited borrowing exemptions for SMSFs, trustees should carefully consider the broader financial, administrative and compliance implications before relying on these arrangements. Borrowing within an SMSF can create opportunities to strengthen the fund’s investment capacity, but it also introduces ongoing responsibilities that require active oversight and prudent decision-making.
Understanding how borrowing exemptions operate in practice can assist trustees in determining whether a particular arrangement aligns with the long-term objectives and financial position of the fund.
Assessing the Financial Position of the SMSF
Before entering into any borrowing arrangement, trustees should evaluate whether the SMSF is in a stable financial position to manage the associated obligations. This includes reviewing the fund’s current cash flow, liquidity and overall asset allocation.
Borrowing arrangements often involve ongoing repayment commitments in addition to expenses such as insurance, maintenance, legal fees, accounting costs and interest payments. Trustees should consider whether the fund can continue to meet these obligations comfortably, particularly during periods of market volatility or reduced investment income.
Maintaining sufficient liquidity within the fund is also important. SMSFs must continue to pay member benefits and cover operational expenses as they arise. Where a large portion of the fund’s assets are tied to a single investment acquired through borrowing, trustees may face limitations in accessing funds quickly if required.
Reviewing the Fund’s Investment Strategy
Trustees are required to maintain and regularly review the SMSF’s investment strategy. Any borrowing arrangement entered into by the fund should align with this strategy and support the retirement objectives of the members.
When considering a borrowing exemption, trustees should assess whether the investment is appropriate for the risk profile, diversification strategy and long-term goals of the fund. Acquiring a significant asset through borrowing may increase exposure to a particular market or asset class, particularly where the investment involves a single property or concentrated holding.
Trustees should also consider the long-term viability of the investment and whether it remains suitable under changing economic or market conditions.
Understanding Long-Term Obligations
Borrowing arrangements within SMSFs are not simply short-term investment decisions. Trustees must manage the arrangement over the life of the borrowing and continue to comply with all relevant legislative requirements throughout that period.
This may include maintaining repayment schedules, monitoring interest obligations, reviewing lease arrangements and ensuring the asset continues to satisfy the relevant SIS Act conditions. Trustees should also be aware that changes to the structure of the asset or borrowing arrangement may create compliance concerns if not carefully managed.
Ongoing oversight is particularly important for Limited Recourse Borrowing Arrangements, where the legal and administrative structure can be more complex than standard SMSF investments.
Maintaining Appropriate Documentation
Accurate and well-maintained documentation is an essential part of managing SMSF borrowing arrangements. Trustees should retain all records relating to the borrowing, including loan agreements, trustee resolutions, trust deeds, repayment schedules and supporting documentation relating to the investment decision.
Proper documentation may assist trustees in demonstrating compliance during the annual SMSF audit process and may also help support decision-making if questions arise regarding the structure or operation of the arrangement.
Incomplete or inconsistent records can create unnecessary compliance concerns and may increase the risk of regulatory scrutiny.
Considering Related Party Arrangements Carefully
Where borrowing arrangements involve related parties, trustees should exercise additional caution to confirm that all dealings occur on arm’s length terms. This includes ensuring that interest rates, repayment conditions and security arrangements reflect standard commercial lending practices.
SMSF-related party transactions that are not conducted appropriately may create compliance issues and could result in the arrangement being reviewed more closely by auditors or regulators.
Trustees should also ensure that any related-party involvement does not breach in-house asset rules or other SIS Act provisions applying to SMSFs.
Preparing for Ongoing Compliance Reviews
SMSF LRBA and other borrowing arrangements are generally subject to ongoing review during the annual audit process. These reviews form an important part of SMSF auditing Australia-wide, particularly where borrowing arrangements involve more complex compliance requirements.
Auditors may assess whether the borrowing satisfies the conditions of the relevant exemption, whether repayments have been managed appropriately and whether the structure of the arrangement remains compliant with the SIS Act. Trustees should therefore maintain clear records and regularly review the arrangement to confirm continued compliance with legislative requirements.
Where uncertainty exists, obtaining professional advice may assist trustees in navigating SMSF borrowing rules and capacity and maintaining compliance over the life of the investment.
Conclusion
The SIS Act was established to protect members’ retirement savings. Within this legislative framework, SMSFs benefit from flexibility. Exemptions under provisions such as Section 67 allow trustees to borrow under limited conditions, thereby enhancing the fund’s investment capacity.
However, with increased flexibility comes greater accountability. Trustees must fully understand the conditions of each exemption, apply them correctly and maintain thorough records to demonstrate compliance. When used wisely, these flexibilities can help an SMSF achieve favourable outcomes for its members.
References:
SIS Act Section 67, 67A, 67B, 66, 71 and SIS Regulation 13.22C