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Frequently asked questions on Self-Managed Super Funds

What is an instalment warrant?        

Traditionally, an “instalment Warrant” now referred to as a “Limited Recourse Loan” is a marketed investment product that enables the investor to acquire an asset, normally listed securities or real estate. This is achieved through the investor paying an initial deposit then borrowing money to fund the remaining amount required to acquire the asset. The borrowing is repaid by the investor making further instalment payments, i.e. a home loan.

The investor purchases the asset that provides an income, i.e. rent or dividends. The investor’s interest in the asset is provided as security for the borrowing. If the investor defaults on the borrowing, the lender may only have recourse to the asset acquired. The lender has no recourse to any other asset of the investor. In simple terms, the funder, usually a bank only has access to the secured asset to extinguish the loan. They cannot touch any other asset belonging to the borrower.

Why has the law changed? 

Previously, super funds were not allowed to borrow money to purchase an asset.

From September 2007, changes to the law meant that super funds were permitted to borrow money to purchase an asset, providing that certain requirements are strictly met.

Do the new rules apply only to Self-Managed Superannuation Funds (SMSFs)?  

No. The new laws apply to all regulated funds, not just SMSFs.

Is it only marketed “Limited Recourse Loan” products which are allowable under the new laws? 

No. The new laws are not limited to only allowing traditional tradable “Limited Recourse Loan” products as a means of a super fund borrowing money to acquire an asset.

Such a borrowing may be permitted under any “Limited Recourse Loan” type arrangement which is structured and carried out in a way such that it satisfies all of the requirements of the new law, i.e. SMSF’s can now borrow money to purchase residential real estate, however there are rules governing such a purpose.

What conditions must be met for borrowing to be allowable? 

Under the new law a super fund is not prohibited from borrowing money, providing the arrangement entered into satisfy each of the following conditions:

  • The borrowed monies are used to acquire an asset which the fund is not otherwise prohibited from acquiring.
  • The asset acquired is held on trust so that the fund receives a beneficial interest in the asset.
  • The super fund has the right to acquire legal ownership of the 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. 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.

What are the consequences if the “Limited Recourse Loan” arrangement does not satisfy all of the required conditions?

If the required conditions are not strictly satisfied, borrowing money under a “Limited Recourse Loan” type arrangement will result in a breach of one or more of the super laws. Such a breach may have civil or criminal consequences.

Is a fund trustee allowed to acquire the underlying asset from a related party vendor?

The laws which prohibit the acquisition of assets from related parties apply to “Limited Recourse Loan” type arrangements.

However, the exceptions provided for in the rules against acquisition of assets from related parties, such as those allowing for the market value acquisition of listed securities or business real property, continue to apply.

Does the requirement that the asset be held on trust for the fund mean that the fund acquires an asset from a related party on repaying the borrowing? 

It is a necessary feature of an arrangement contemplated by the law that the super fund be able to acquire full ownership rights over the underlying asset once the borrowing is repaid.

The security trust which holds the asset underlying a “Limited Recourse Loan” arrangement will be a related party of an SMSF. In these circumstances, the legal interest in the asset may be considered to be acquired from the security trust when the borrowing is repaid.

Can the trust which holds the asset be a unit trust? 

No. A unit trust cannot be used as the security trust holding the asset underlying a “Limited Recourse Loan” arrangement. The use of a unit trust will result in the fund not meeting the conditions that need to be satisfied under the new laws that allow super funds to borrow.

Is a fund allowed to put an existing fund asset into a “Limited Recourse Loan” arrangement? 

No. The requirement that the money borrowed must be applied for the acquisition of an asset (or any replacement) means that “Limited Recourse Loan” investments by way of “shareholder applications” or “cash extraction” arrangements are not allowed. The giving of a charge over an existing asset of the fund, as would generally occur under such arrangements, would also result in a contravention of the operating standards that apply to the trustees of super funds.

Is a fund allowed to borrow from a related party? 

The new law does not of itself prohibit the lender from being a related party.

However, super funds must continue to comply with other legislative requirements. For example, the super fund must satisfy the sole purpose test and comply with existing investment restrictions such as those applying to in-house assets and acquiring certain assets from a related party of the fund.

Does interest on a borrowing from a related party need to be at commercial rates? 

A borrowing by a trustee of a super fund from a related party at zero or less than commercial rates of interest may raise concerns as to whether the payment received is not a borrowing but is in fact a contribution.

Further, a borrowing from a related party at a rate of interest exceeding commercial rates may raise concerns as to whether the fund is being maintained solely for the purpose of providing superannuation benefits.

Does the arrangement entered into by the fund trustee actually involve a borrowing? 

It is essential that appropriate documentation clearly reflect that the trustee of a super fund has made a genuine borrowing to acquire an asset.

This is particularly the case where the monies provided to acquire the asset are from a related party. Without adequate documentation to substantiate monies provided by a related party as being by way of a borrowing, it is likely that the monies will to be treated as a contribution received by the fund. This could lead to significant tax consequences should it result in a contributions cap being exceeded.

Will granting the lender a right of recourse over the underlying asset lead to a breach of the prohibition against charging a fund asset? 

The granting to the lender of a right of recourse to the underlying asset at the same time that the trustee of a super fund acquires the beneficial interest in the asset is a necessary feature of an arrangement contemplated by the changes to the law.

The Tax Office and APRA are of the common view that the granting of such a right in these circumstances will not of itself contravene the existing prohibition in the law against giving a charge over a fund asset provided that the arrangement complies with all the conditions of the new law.

Can a fund trustee enter into a “Limited Recourse Loan” arrangement if its governing rules do not allow the fund to borrow? 

No. The governing rules of a super fund must allow the trustee of the fund to borrow before any “Limited Recourse Loan” type arrangement can be entered into.

Can a fund trustee enter into a “Limited Recourse Loan” arrangement if it is not consistent with the fund’s investment strategy? 

No. A trustee of a super fund can only enter into such an arrangement where this is consistent with the investment strategy formulated in relation to the fund.

How does my SMSF purchase a property?

•     The SMSF obtains a loan approval from an accredited lender.

•     The SMSF selects the property it wishes to purchase.

•     Residential property must be purchased at arm’s length and from a non-related vendor

•     Commercial property can be purchased for full value from related parties so long as the property            is for business purposes

•     A special purpose company is established to act as Trustee for a special purpose Bare Trust.

•     An SMSF solicitor/conveyancer is engaged to facilitate the purchase.

•     The SMSF pays the deposit

•     The balance of the funds required are borrowed by the special purpose company acting as trustee            for the Bare Trust.

•     The SMSF pays for legal costs, and stamp duty.

•     The special purpose company acting as trustee for the Bare trust mortgages the property to the                lender

•     The SMSF then manages the asset.

Can an SMSF trustee or member occupy the property?

No. If a member of the SMSF occupies the property the “sole purpose test” would be breached.

What are the new rules that permit borrowing in an SMSF?

Under the new Section 67 of the Superannuation Industry (Supervision) Act 1993, SMSF’s can borrow providing the following conditions are satisfied;

•     The borrowed funds are used to purchase an asset.

•     The asset is held in Trust for the SMSF by another entity.

•     The SMSF must have the right to acquire legal ownership of the asset

•     The lender’s recourse against the SMSF must be limited to the underlying asset and not other                   assets of the SMSF

•     The lender has no right of recourse against any other assets of the SMSF fund

Who pays what and when?

The SMSF is responsible to pay for the following;

•     Council Rates, Water Rates, and Land Tax

•     Interest and other loan repayments

•     Lenders fees

•     Repairs

•     Property management costs; and any insurance premiums & management fees imposed by the              Property.

What about Land Tax?

Land tax is payable by the SMSF only if total land values exceed the prescribed amount.

Can an SMSF sell the property?

The SMSF can direct the Property Trustee to sell to any Third Party.

What happens when the loan is fully repaid? 

Subject to future changes in the relevant laws, when the loan is fully repaid, the SMSF is entitled to have the legal title transferred to the SMSF fund. With the correct Trust structure, this transfer will not attract GST or Stamp Duty liabilities as the SMSF will already be the beneficial owner.

Who can be the Property Trustee?

The Property Trustee should be an arm’s length Trustee from the SMSF Trustee and the members of the SMSF. A special purpose trustee company can be established to facilitate this requirement.

 

 

 

 

 

 

 

 

 

 

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