Borrowings by self-managed superannuation funds (SMSFs) to purchase investment properties and other assets have become increasingly popular since changes to the legislation. Here we take a look at the dangers and pitfalls if the purchase is not structured properly and offer tips for funds wanting to borrow to purchase real estate.
The prohibition on SMSFs borrowing to purchase assets was eased in 2007. These transactions are known as “limited recourse borrowing arrangements” or “instalment warrant borrowings” and are regulated by the Superannuation Industry (Supervision) Act 1993 (SIS Act)
In July 2010 the Government made further amendments to the SIS Act and they became effective from 6 July 2010.
The amendments have resulted in some tightening of the rules and clarification of some contentious issues surrounding this form of borrowing. It should be noted that further clarification resulting from the discussion of the new provisions between the Commissioner of Taxation and the professional bodies is expected.
The essential elements of SMSF borrowing arrangements have not changed; a SMSF can borrow to acquire any form of asset, as long as the borrowing is “limited recourse” – i.e. the financier must be prepared to limit its recovery rights in such a way that no other assets of the SMSF are at risk if there is a default.
The only recourse of the financier against the SMSF is to the asset for which the borrowing was made.
In other words, the mechanism by which limited recourse borrowing operates is that the SMSF (through its trustee) borrows the money from the financier for the purchase of an asset. The asset can then purchased by a company (usually newly-formed) that holds that asset under a trust deed. This is done as custodian or nominee for the SMSF (Custodian Company) during the period of the loan and any mortgage or other security for the borrowing is granted by the Custodian Company in favour of the financier.
Once the debt to the financier has been repaid, the Custodian Company must transfer the asset to the trustee of the SMSF and from that time it is held in the same way as the other assets of the SMSF.
New Rules operate from 6 July 2010
There are a number of important features of the amendments:
What’s in a name?
- The term “instalment warrants” has been abandoned and the preferred description going forward is “limited recourse borrowing arrangements”.
A separate borrowing arrangement is now required for each asset acquired
- Only a single acquirable asset can now be the subject of each limited recourse borrowing. In other words, for each asset acquired after 6 July 2010 using this form of funding arrangement, there must be separate borrowing and security documentation. In some cases there may be advantages in ensuring that old borrowing arrangements are not brought to an end.
- There is an exception to the new single acquirable asset rule where there is “a collection of assets that are identical and have the same market value”. This will apply to purchases such as portfolio investments such as shares, unit trust units etc. – but it is limited to shares or units in a single company and involving shares or units with identical rights.
- However the exception will not apply to a land purchase involving different strata title lots in the same subdivision of land or where a SMSF is acquiring several “off the plan” lots in an industrial or residential estate. Each lot must be treated as a separate borrowing with its own limited recourse security arrangement.