Super borrowing – top 10 tips and some alternatives
Scott Hay-Bartlem, Partner, SMSF Specialist Advisor
11 October 2013
www.cgw.com.au
Overview
• Super borrowing been with us some years
• Downside of getting it wrong is quite
serious…
• Becoming more common
• Quite technical
• Top 10 tips
• Some alternatives
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A summary of the rules…
• SMSF trustees generally not allows to
borrow
• Section 67A Allows trustee of SMSF to
borrow
•
Asset held on trust
•
SMSF gets title after paying instalments
•
Lender’s (and others’) right limited to asset
•
Asset SMSF could have acquired
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1. Get the structure right
• SMSF borrows
• Bare trust owns the asset
• If not
•
Borrowing prohibition
•
In-house asset
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1. Get the structure right
members
Guarantees
Contributes funds
Bare
Trust
$$$
Bank
SMSF
Sole Beneficiary
Purchases
non-recourse
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2. What asset?
• The SMSF must have been able to acquire
•
In-house assets
•
Buying from related parties
•
Business real property
•
Listed securities
•
Some allowable in-house assets
•
Market value
•
Usual terms
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2. What asset? (cont’d)
• Single acquirable asset SMSFR 2012/1
•
Single legal thing unless identical and identical
value
•
One title
•
Must sell together legally
•
‘Unifying physical object’
•
‘Permanent in nature’
•
‘Not easily removed’
•
‘Significant in value relative to the value of the
asset’
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2. What asset? (cont’d)
• Examples
•
Strata lot + car park if must go together
•
Building over two lots
•
Off the plan + deposit
•
Option + subsequent purchase
•
Multiple drawdowns
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3. Can I change the asset?
• Limits on replacement assets
•
•
Repair
•
Occasional and partial
•
Restores function of asset without changing
character
Maintain
•
Prevent defects, damage or deterioration
•
Includes anticipation of defects
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3. Can I change the asset? (cont’d)
•
•
Improve
•
Significantly altered for the better
•
Substantial alterations
Reference made to asset at time of acquisition
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3. Can I change the asset? (cont’d)
• Examples
•
Addition of dishwasher
•
Fence
•
Swimming pool
•
Granny flat
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4. Can a related party be the lender?
• Yes, but
•
•
Arm’s length terms – would the bank have
done it and what would the loan look like?
•
Repayments
•
Interest rate
•
Document
•
Security
•
Guarantees
If loan from a company, Division 7A
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4. Can a related party be the lender? (cont’d)
• NTLG minutes June 2012
•
No or discounted interest loans
•
Not arm’s length breach or contribution
•
Non arm’s length income
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5. Can a related party use the asset?
• Yes, but
•
Written lease
•
Arm’s length terms
•
Tenant improvements
•
Wholly and exclusively used in a business
•
Sole purpose
•
For example, Montgomery Wools case
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6. When the loan is paid off…
• ATO – must transfer the asset to the fund
•
Section 71(8) exemption from the in-house
asset rules cease to apply
• CGT?
•
‘Absolutely entitled’?
•
‘Look through’ treatment proposed (still waiting
on legislation)
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6. When the loan is paid off… (cont’d)
• Duty
•
S130B (new exemption)
•
‘Nominee contract’ provisions
•
•
CGW has been successful
Or duty on value of asset at time of transfer…
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7. Update the investment strategy
• Section 52 covenant
•
Formulate and update
• Does it deal with
•
•
•
•
•
Proposed investment
Borrowing
Increased risk
What happens on death of member
Insurance
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8. What if a member dies?
• If member dies with borrowing in place,
what does the fund do?
•
Breach of loan/guarantee?
•
Are we required to pay a lump sum?
•
Can we pay a pension?
•
Can we transfer part of an asset?
•
Are there other assets in the fund to provide
benefit?
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8. What if a member dies? (cont’d)
• Unallocated insurance
•
Provides cash for paying out the interest
•
Does not form part of the benefit
•
Trust deed must allow (most do not)
•
Premiums not from accumulation account
•
Contribution caps as allocate from reserve
•
Deductibility of premiums?
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9. Can two SMSFs have one bare trust?
• No
• One trust per SMSF
• For multiple fund investments, look at
•
Unit trust
• Joint SMSF
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10. SMSF trust deed
• Does it allow?
•
Borrowing power
•
Often absolute prohibition pre-2007
•
Refer to repealed s67(4A)?
•
Buy particular asset
•
Power of attorney
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Some alternatives
• Unit trusts
•
•
•
•
•
Ungeared
Unrelated
Pre 1999 unit trust
Installment contract/vendor finance
‘Joint venture’
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Ungeared unit trusts
• Exempt from in-house asset rules
• Strict Requirements (Regs 13.22B & 13.22C)
•
•
•
•
•
•
•
No debt or charges
No loans, or investments in other entities
Not acquired assets from related party (except
business real property)
Not lease assets to related party, except BRP
Not carry on a business
Arm’s length terms for all transaction
If breach, investments become in-house assets
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Ungeared unit trusts (cont’d)
• Very restrictive
• Tangible assets only
• If breach, the exemption
•
Ceases to apply to the existing investment in
that entity
•
Can never apply to any further investment in
that entity
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Ungeared unit trusts (cont’d)
• Example
•
•
•
•
•
•
Abbott SMSF establishes unit trust as sole
unitholder
Unit trust buys real estate from arm’s length
party and leases to arm’s length tenant
No borrowings, charges etc.
Ungeared exemption can apply and units are
not in-house assets
SMSF could borrow to acquire
But not buy from a member?
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Ungeared unit trusts (cont’d)
• Example
•
Unit trust borrows to buy more real estate
• Ungeared entity exemption no longer applies units now an in-house asset
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Unrelated unit trusts
• In-house asset rules only apply to a ‘related
trust’
• ‘Related trust’ if ‘group’ has:
•
Fixed entitlement more than 50% of income/
capital
• ‘Control’ of trustee
• Ability to appoint remove the trustee
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Unrelated unit trusts (cont’d)
• ‘Control’ of trustee
•
•
•
•
•
Effective control - directions or wishes of the
group
Majority of trustees?
Majority of directors?
Majority of shares in corporate trustee?
Tie breakers – casting vote?
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Unrelated unit trusts (cont’d)
• ‘Group’ - s70E(3)
•
Member + Part 8 associates
•
Standard employer-sponsor + Part 8 associates
• Part 8 Associates (s70A, 70B, 70C)
•
Relatives
•
Tax law partnerships, other partners, spouses and
children
•
Other controlled entities
•
More than 50%
•
Effective or practical control
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Unrelated unit trusts (cont’d)
• Example SMSF 1 & SMSF 2 are unrelated
•
Each SMSF is completely unconnected and
has 50% of units in unit trust
•
Trustee is a company
•
Two directors from each SMSF
•
No casting vote
SMSF 1
Unrelated
unit trust
SMSF 2
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Unrelated unit trusts (cont’d)
• SIS Act does not apply
•
Units not in-house assets
•
Borrow and charge its assets
•
Invest in other entities, including related parties
and trusts
•
Acquire assets from related entities
•
Acquire multiple assets
•
Develop/improve
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Pre 1999 unit trust
•
•
•
•
Rules changed 1999
Some grandfathered old trusts still out there
Often able to buy new assets and borrow
Where clients have them, can be better
answer than LRBA
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Limitations - unrelated unit trusts
• SIS Act – I thought it did not apply?
Section 62 – sole purpose test
• Section 65 – financial assistance
• Section 109 - arm’s length terms
•
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Summary
• Are opportunities
• And traps – need to get it right!
• Be aware there are other options
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Limitations - unrelated unit trusts (cont’d)
• Anti-avoidance
Section 66 – related party acquisitions
• Section 85 – in-house assets
• Section 71(4) – ATO discretion
•
• Cannot buy out other unitholder
•
Ungeared entity exemption????
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Thank you
Scott Hay-Bartlem
Partner
TEP, SMSF Specialist Advisor
www.cgw.com.au