News 07/08

Super Concepts e-SuperUpdate provides you with technical tips and updates on Self Managed Superannuation Fund topics of interest.

Earlier this year we published an e-SuperUpdate on the new rules which allow a super fund to borrow, also referred to as instalment warrants. In February Super Concepts held seminars on how the new borrowing rules could be used successfully and provided some alternatives by using certain trust arrangements. Since that time we have answered many questions on how instalment warrants work. In this edition of e-SuperUpdate we cover some of the questions clients have asked to assist you in understanding the breadth of these new borrowing requirements.

What are the new borrowing requirements for superannuation funds?

From 24 September 2007 the new borrowing requirements, which are also referred to as instalment warrants, permit a superannuation fund to borrow in limited circumstances:

• The amount borrowed by the fund must be used towards the purchase of an investment which the fund would be permitted to acquire under the superannuation law.
• The investment acquired is held on trust for the fund and once the loan has been paid off it is transferred to the fund.
• It is possible to exchange the investment held on trust for another.
• If there is a default on the loan then the lender is limited to recover the amount of the loan outstanding from the sale of the investment and not from other investments of the superannuation fund.

Are self managed superannuation funds able to use the new borrowing rules?

Yes, the new borrowing rules apply to all superannuation funds including self managed superannaution funds.

Are there any restrictions on the investment that can be acquired as part of the borrowing arrangement?

The investment must be one that the superannuation fund could acquire under the superannuation law. As a general rule there is no restriction on the type of investment that can be acquired such as property or listed shares and other securities. However, the investment subject to the loan cannot be an investment the fund already owns. In addition, the superannuation law places restrictions on investments that can be acquired from related parties such as fund trustees, members, relatives of members or trustees and any entity they control either individually or as a group. It is worthwhile to obtain advice in this regard as these rules can be complex.

What rules apply to the loan?

Any loan that the superannuation fund obtains for purposes of the new borrowing rules must satisfy the following conditions:

• The loan must be acquired for purposes of acquiring an investment permitted under the superannuation laws.
• The investment, or its replacement, is held on trust so that the fund receives the beneficial interest in the investment. The beneficial interest includes the right to income earned by the investment.
• The superannuation fund acquires the right to legal ownership of the investment after one or more payments have been made.
• The lender is limited to recover any outstanding amount relating to the loan only from the sale of the relevant asset. The lender does not have the right to recover any of the outstanding loan from the other investments of the superannuation fund.

What happens when the loan is repaid?

When the loan is repaid the legal ownership of the investment is transferred to the superannuation fund. Of course, prior to the transfer of the investment to the superannuation fund it is possible for the investment to be sold. Any profit made on the sale of the investment will be transferred to the superannuation fund. However, any loss that is made will become the responsibility of the lender as the terms of the loan are on a limited recourse basis. This means that the lender is only able to recover the amounts outstanding on the loan from the sale of the investment subject to the loan.

Can the fund borrow from a related party?

Yes, the fund can borrow from a related party. However, it must be ensured that the transaction complies with the superannuation law. For example, the fund is required to meet the sole purpose test and meet the investment restrictions such as ensuring the whole transaction is made on an arm's length basis.

In the case of the purchase of real estate who pays the deposit and the final amount on settlement of the purchase?

It is the superannuation fund which pays the deposit for the property. On settlement, the lender would provide a cheque to the value of the loan and the superannuation fund may provide additional funds to make up the whole of the purchase price.

Once the property has been settled the legal title for the property would be in the name of the trustees of the bare trust.

Which entity is responsible for the accounting for the borrowing arrangement?

The superannuation fund is the entity which will account for the income and expenses of the borrowing arrangement. It is understood that the fund will also pay tax on any net income it receives from the investment. Also, any net loss that is made by the superannuation fund on the borrowing arrangement will be deductible against the other income of the fund. This should be confirmed with the tax adviser for the fund.

Who is able to act as trustee of the bare trust?

The trustee of the bare trust can be a company or indiviudal. However, the trustee of the bare trust should not be identical to the trustee of the superannuation fund. For example, if the trustee of the superannuation fund is XYZ Pty Limited then another company or individuals must be trustees of the bare trust. If the trustees of the superannuation fund were Mr and Mrs Smith then they both cannot be trustee of the bare trust. However, Mr Smith or Mrs Smith could be trustees of the bare trust.

If the trust deed of the superannuation fund prohibits the fund from borrowing, can it borrow for purposes of the new legislation?

No, if the trust deed of the superannuation fund places more stringent restrictions than the superannuation law then it is not possible for the fund to borrow. Please note that the most recent Super Concepts trust deeds permit the trustee to borrow for purposes of the new borrowing rules.

Does the fund need to review the investment strategy of the fund?

It is worthwhile to review the investment strategy of the fund to make sure it is able to borrow to invest for purposes of the superannuation law.

Is the interest paid on the loan tax deductible to the superannuation fund?

Our undertsanding is that under the income tax law expenses that are incurred in gaining or producing assessable income are tax deductible. If the superannuation fund receives income from the renting of a property or dividends from share investments then any expenses, including interest on any loan used to purchase the investment, would be tax deductible. This should be confirmed by the fund's tax adviser.

When the investment is transferred to the superannuation fund after the last payment has been made, is the transfer the disposal and acquisition of an asset for purposes of the capital gains tax legislation?

Our understanding is that as there is no change in beneficial owners but merely a change in legal owners of the investment and there is no capital gains tax event for purposes of the tax legislation. In the circumstances the superannuation fund will always be the beneficial ownser of the investment. This should be confirmed by the fund's tax adviser.

If the investment is sold by the bare trust prior to transfer to the superannuation fund is the sale a disposal of an asset for purposes of the capital gains tax legislation?

Our understanding is that as there is a change in the beneficial owner of the investment and there is a capital gains tax event for purposes of the tax legislation. In the circumstances the superannuation fund, as beneficial owner of the investment, has disposed of the investment. This should be confirmed by the fund's tax adviser.

What are the stamp duty implications of the purchase of the property?

The laws relating to stamp duty vary from State to State. It is usual that on the purchase of a property that stamp duty is payable. However, it is understood that in some circumstances and in some States no stamp duty is payable. Further information on the stamp duty implications of the transaction should be obtained from a specialist tax adviser.

Can the bare trust be used to acquire more than one investment?

The new borrowing legislation provides that only one investment, or its replacement or a replacement of the replacement, is held in the bare trust. If more than one investment is held our legal advisers have indicated that it is advisable to have a trust declared over each individual investment.

Can the borrowing arrangement be used for purposes of property development or to improve a current property that is held subject to the bare trust?

Improvement of an existing investment creates a number of problems as the loan obtained by the fund is to be used to acquire a particular investment. If the particular investment, such as a block of land, already forms part of a borrowing arrangement then it is not possible to improve or develop the property as this will result in a material change to the investment that was acquired initially.

What documentation does Super Concepts have available for the new borrowing arrangements?

Super Concepts have a full range of documents for the new borrowing requirements. Documents and services include:

• Declaration of Trust
• Borrowing agreement
• Equitable mortgage documentation
• Information Memorandum
• Required Minutes
• Technical backup and support

These documents are eminently suitable where the loan is being obtained from a private source. However, if a bank or financial institution is being used then they may wish to substitute some of the borrowing documents with their own.

Further Questions

We have created a more extensive document on Frequently Asked Questions about Borrowing and Your SMSF and this can be downloaded from the SuperAssist section of the website.