In technical terms it is necessary to consider both the physical object and the proprietary rights comprising the asset, to determine if the character of the asset as a whole has fundamentally changed. This approach is entirely consistent with the EM, which prohibits improvements if they result in a new asset. It also appears to address concerns raised in the EM that a substantial change to the acquirable asset may change the nature of the asset used as security by the lender, which in turn potentially increases the risk of the fund. This approach also enables the use of insurance proceeds to rebuild a property destroyed or damaged by an insurable event such as a fire or cyclone. The ATO’s previous preliminary view on this issue was that the insurance proceeds must be used to repay the loan and not used to rebuild the property. Because the reconstruction or repair is not being financed by a borrowing under the LRBA, it is irrelevant whether or not the construction merely repairs or improves the property.
However, it is important that the repair or reconstruction does not result in a different asset from the original asset acquired under the LRBA. Whether a change to the acquirable asset results in a fundamentally different asset to the asset acquired under the LRBA must be determined on the facts of each case by reference to the legal and physical characteristics of the asset. An important consideration would be whether or not the acquirable asset has been altered to such an extent that it now has a different function or purpose. Another important consideration would be whether the asset has been entirely replaced by another asset, as this would constitute a new asset under section 67B of the Act. The draft ruling uses the example of a house that is destroyed by fire and is subsequently rebuilt using the insurance proceeds. As rebuilding the house is restoring the asset to what it was at the time of entering into the LRBA, it does not result in a new asset for the purposes of section 67B of the Act.
Although the house has been entirely replaced, the acquirable asset itself has not been entirely replaced because it has been constructed on the same land as the previous house. However, what if when rebuilding the house an additional shed is also constructed, which is used for commercial purposes? In this situation, a further assessment would need to be undertaken to determine whether or not the acquirable asset is now serving a different function and purpose to that previously served by the asset originally acquired under the LRBA. In contrast, if a piece of equipment, which is purchased under an LRBA, is subsequently destroyed, it cannot be replaced with a new piece of equipment, as the new piece of equipment would constitute a new asset under section 67B. The piece of equipment in this situation has been replaced in its entirety and the replacement piece of equipment is not covered by section 67B. Interestingly the draft ruling uses the example of a property that is damaged by a cyclone and states that the addition of a second storey to the house at the time the house is repaired would constitute an improvement but not a new asset for the purpose of section 67B. Similarly the addition of a new pool or a new garage would be an improvement but not a new asset for the purposes of section 67B. Assuming this view prevails in the final ruling, it suggests SMSF trustees may have some “wriggle room” in terms of the extent of changes that can be made to a property under an LRBA without breaching the replacement asset rules in section 67B.
