News 07/08

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

Until late last year super funds were severely restricted from borrowing directly except for some very limited exceptions. If the trustee wished to gain access to gearing, the fund was basically required to invest in publicly available geared share trusts, listed investment companies and, to a limited extent, some private companies or trusts.

However, changes to the superannuation rules late last year mean that superannuation funds can borrow directly providing the purchase of the investment is done in a special way as an instalment warrant. Instalment warrants are not a new invention and have been around with the large institutional banks for many years. What these new rules mean is that you can arrange via your self managed super fund to finance the purchase of investments as part of your superannuation wealth building strategy.

The main benefit of using an instalment warrant is that you can bring forward the purchase of a business property or other investment. This means that you don't need to wait until your super fund has enough funds to purchase the investment outright. You can now do that as part of your long term retirement savings strategy rather than wait until you are nearer to retiring. Also, an instalment warrant may allow you to make a loan to your superannuation fund and not get caught up in penalties that apply if you have the potential to breach the concessional and non-concessional contribution caps.

Let's see how an instalment warrant works. If you wish to meet the requirements of the new rules the first thing to do is find the appropriate investment. The investment must be consistent with the investment strategy of the fund and it must be one that the fund is able to purchase under the superannuation rules. For example, it would be permissible to purchase a residential property from an unrelated third party or a commercial property. In making the decision, careful attention should be given to the risks associated with including gearing in the investment strategy of the fund and we recommend that you seek the advice of your financial planner and/or accountant before proceeding.

Th next step is for your fund to obtain a loan so that the investment can be purchased. There are a number of special requirements if the loan is to satisfy the new rules. The first is that it must be used wholly to purchase the investment which will be held in trust for the superannuation fund. The second is that the loan must be made on a non-recourse basis. This means that in the event of the superannuation fund defaulting on repayment of the loan the lender only has the right to recover an amount up to the value of the investment that is subject to the loan. Therefore the super fund is only liable to the value of the investment and no more. For this reason you may find that banks and other institutional lenders restrict the amount of the loan. Under the rules there are no limitations on related parties making loans to the fund for purposes of the instalment warrant.

The legislation for instalment warrants also requires that the investment is held in trust for the superannuation fund which is done though an 'instalment trust'. Once the loan has been repaid the ownership of the property will be transferred to the super fund. In some cases the superannuation fund may wish to 'replace' the investment subject to the instalment warrant with another. For example, the superannuation fund may originally purchase a commercial property as part of the warrant and replace it with another due to business expansion or change of location.

Example

Wayne who is age 45 and his partner, Michelle, who is 43, are members of a self managed superannuation fund. The fund currently has total asserts of $500,000 invested across a range of assets, $50,000 in cash and the balance in fixed interest, shares and indirect property. Michelle has identified a suitable commercial property that she wishes the fund to purchase. She expects the fund will pay about $400,000 to purchase the business property and also the fund could incur a possible CGT event.

Subject to the investment strategy of the self managed superannuation fund the business property could be purchased in the circumstances by selling most of the fund's investments to effect the purchase. This would mean the fund would have significant exposure to property.

However, by using an instalment warrant arrangement it is possible for the fund to commit less assets of the fund to purchase the property investment. It will also allow some diversification of the fund's investments while, at the same time, increasing the exposure of the fund to property via gearing.

Let's say that the fund uses $50,000 cash and obtains a loan of $350,000 to purchase the property via an instalment warrant arrangement. Over time the fund will make payments to reduce, and even eliminate the outstanding loan plus any interest payable. If the business property is leased to Michelle for her business she will be required to pay an arm's length commercial rent for the property. Once the loan is fully paid the title to the property will transfer to the self managed superannuation fund.

The introduction of the expanded legislation for instalment warrants presents a new opportunity for superannuation funds to borrow for investment. Don't forget that it is advisable to seek the help of a professional to ensure that you are correctly using the advantages available under the new instalment warrant rules.