When is an SMSF borrowing improvement allowed?

On 14 September 2011, the Australian Taxation Office (ATO) released Draft Self Managed Superannuation Funds Ruling SMSFR 2011/D1 (the draft ruling). The draft ruling explains key concepts relevant to borrowing in Superannuation funds. Importantly, the draft ruling clarifies the ATO's view on property improvements.   Previously a SMSF was unable to improve an asset purchased using a loan, or to rebuild the asset in the event the asset was destroyed by fire, flood, cyclone or similar.

Fortunately, the ATO now takes a different approach.  Paragraph 30 of the draft rulings says: "Although borrowings cannot be used to improve a single acquirable asset, money from other sources could be used to improve (or repair or maintain) that asset. However, any improvement must not result in the acquirable asset becoming a different asset"  Essentially, this paragraph says that borrowed funds must not be used to improve an asset purchased using a loan agreement, but other cash in the fund can be used to improve the asset as long as the improvement does not change the asset to such an extent that it becomes a completely different asset. 

So what is the difference between an improvement and a repair?

A repair has been defined as “remedying or making good defects in, damage to, or deterioration of an asset and contemplates the continued existence of the asset”, whereas an improvement is defined as “if the functional efficiency of the asset or the value of the asset is substantially increased through the addition of new and substantial features or rights or bringing a thing or structure into a more valuable or desirable form, state or condition then a mere repair would do”.

Some examples are: 

·         Building a house on a vacant block of land = Improvement

·         House is demolished and three units are built on the block = Improvement

·         Land is re-zoned and a residential property is updated, becoming a commercial property = Improvement

·         Four bedroom house is rebuilt after fire destroys the house = Repair, so long as it was previously a four bedroom house (i.e. the characteristics do not change significantly)

Currently SMSFR 2011/D1 is in draft format.  It has been released for comment and as such, only provides an insight into how the ATO will treat the above issues if there is a breach.  It is the ATO’s intention that if there is no changes to the ruling, that it will be retrospective to 7 July 2010.

Neil Wilde
Superannuation Manager