The announcement of new provisions for permitting self-managed superannuation funds (SMSF) to borrow was greeted with surprise, speculation and suspicion.
Originally expected to cover only traditional instalment warrant arrangements, the new legislation that came into effect on 24 September 2007, clearly applied far more widely. Was it a mistake? Would the new government over-turn it? How would the ATO react?
One year on, we have seen the following:
- No signs that the current government will seek to repeal this legislation.
- An ATO taxpayer alert that provides guidance of the ATO’s views on arrangements, which may concern them (and confirmation of arrangements, which fit within the guidelines).
- Banks, legal practitioners and advisers setting up documentation to enable straight forward and more elaborate borrowing arrangements.
In this article we look at the basic conditions of the legislation, some typical borrowing arrangements and some issues to watch out for.
Basic Conditions for SMSF Borrowing
Section 67 of the SIS Act sets out the prohibition on borrowing, which applies for a superannuation fund. It then sets out the exceptions to this prohibition, and the new rules are contained at section 67(4A) as one of the exceptions.
Under the new law a super fund is not prohibited from borrowing money or maintaining a borrowing of money, providing the arrangement entered into satisfies each of the following conditions:
- The borrowed monies are used to acquire an asset that the fund is not otherwise prohibited from acquiring.
- The asset acquired (or a replacement asset) is held by a security trustee under a bare trust arrangement so that the fund receives a beneficial interest in the asset.
- The super fund has the right to acquire legal ownership of the asset (or, if applicable, the replacement asset) by making one or more payments after acquiring the beneficial interest.
- Any recourse that the lender has under the arrangement against the super fund is limited to rights relating to the asset acquired (or, if applicable, the replacement asset). That is, the lender is able to have the right to recover monies where there is a default on the borrowing by repossessing or disposing of the asset acquired, but cannot have the right to recover such monies through recourse to the fund’s other assets.
Arrangements which may be allowed under the new rules
The following diagram illustrates a basic borrowing arrangement, where monies are borrowed from a lender (a bank or a related party) and are used to acquire an asset in the name of a security trustee under a bare trust arrangement where the fund beneficially owns the asset.
Alternative arrangements
Provided the basic conditions are met, the lender may be a related party. Related party lenders may lend their own cash to the fund under a super fund borrowing arrangement. Alternatively, a related party lender may borrow money on a full recourse basis (using a non-super asset as security) and on-lend this money to the fund on a limited recourse basis.
LVR limits
There are no limits imposed by legislation on the ratio of the loan amount to the value of the underlying asset acquired. However, bank lenders will typically impose lower loan to value ratios (LVRs), unless they can obtain personal guarantees to offset their risk (see warning about personal guarantees), or charge significantly higher interest rates. Related party lenders will perhaps be more flexible about LVRs. However, this should be reflected in the loan terms, otherwise, the loan may not be on commercial terms.
Issues to watch out for
Personal Guarantees: it is important to ensure that where personal guarantees are required to support super fund borrowing, the guarantor has no right of indemnity to the super funds assets, (which would normally be the case unless this right is specifically removed).
Commercial Terms: the ATO taxpayer alert highlighted potential concerns where loans are made on terms, which are not arms length. Care should be taken for related party loans, to ensure that interest rates are appropriate, and reflect what may be available commercially.
Fund Compliance Requirements: a full review of the fund’s investment objectives, investment strategy and trust deed should be undertaken prior to entering into a borrowing arrangement. Issues to look for include:
- Whether the proposed arrangement fits the fund’s investment objectives?
- What impact the gearing arrangement will have on the fund’s future cash flow?
- Whether the fund’s trust deed allows borrowing?
- Whether the fund’s trust deed or investment strategy allows beneficial ownership of fund assets?
It seems likely that SMSF borrowing arrangements are here to stay and that the industry will continue to grow in confidence in advising clients on using gearing within superannuation funds to help clients achieve their wealth creation objectives.
Andrew Blackwell, Sydney
ablackwell@moorestephens.com.au
http://moorestephensresources.com.au