Session 4B:
Instalment Warrant Strategies
(Limited Recourse Borrowing)
Daniel Butler
Director, DBA Lawyers
www.dbalawyers.com.au
2011 SMSF National Conference
Roadmap
• Introduction to SMSF Borrowing
• Comparison between the old s 67(4A) and current ss 67A and 67B
of the SISA
• Unresolved Issues
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concept of single acquirable asset
true nature of holding trust
off the plan purchases
transfer of title
• Recent ATO IDs
• Tax and licensing rules
• Summary
2011 SMSF National Conference
Introduction
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History: SMSF investment in instalment warrants (IWs)
– IW = interest in a trust over an underlying asset.
– Investor makes instalment payments and then acquires asset.
– Typically shares, eg, 40% of T3 investors reportedly super funds.
Super funds prohibited from borrowing: s 67
ATO, APRA: concerned that IWs like a ‘borrowing’.
Government announced plans to clarify the law.
Section 67(4A):
– applied from 24 Sep 2007 to 6 July 2010
– allows trustee to borrow to buy any asset a fund could normally buy
– not strictly an IW: allows direct borrowing by trustee
Sections 67A and 67B
– Introduced with effect from 7 July 2010
– Aimed to clarify s67(4A), but still unresolved issues
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Borrowing: typical structure
SMSF provides
purchase $ to
security trustee
Vendor
$ repayments
SMSF
lender
$ loan
Mortgage
$ rent or
other income
Security trustee/
bare trustee/
custodian/DIT trustee
role should be
minimal
holds legal title
asset being acquired
(eg, real estate)
No mortgage or
any other
recourse
Other SMSF
assets
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Section 67(4A) — features
• Effective from 24 Sept 2007 to 6 July 2010 inclusive
• Borrowing must have the following features:
– Money applied for the acquisition of an asset
– Asset must be one the SMSF could invest in directly
– Asset (or replacement asset) held on trust so SMSF acquires
beneficial interest in asset (or replacement asset)
– SMSF has right to acquire legal ownership of asset (or
replacement asset) by making one or more payments
– Lender’s rights against SMSF trustee for default limited to
underlying asset (or replacement asset)
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Sec 67A and s 67B – six major changes
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Effective from 7 July 2010. Contains SIX major changes:
Headed ‘Limited recourse borrowing arrangement’ — no mention of IWs (1)
Borrowing must have the following features:
– Money applied for the acquisition of an ‘single acquirable asset (2)’
• can include refinancing (3)
• can include repairs and maintenance but not improvements (4)
• can include borrowing to pay for conveyancing fees, stamp duty, etc
– Acquirable asset held on trust so SMSF acquires beneficial interest in asset
– SMSF has right to acquire legal ownership of asset (or replacement asset) by
making one or more payments
– Rights of lender and any other person (5) against SMSF trustee for default
limited to acquirable asset [ie, relevant for guarantees]
There has been detailed clarification as to when a single acquirable asset can be
replaced (6)
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Current issue – single acquirable asset
• An acquirable asset is an asset that is:
– not money (whether Australian currency or currency of
another country); and
– not prohibited by the SISA, SISR or any other law (eg, state
trustee legislation).
• A collection of identical assets with the same market value
(fungible assets) is treated as a single acquirable asset, eg, 100
ordinary BHP shares.
• But is a property which is spread over multiple titles considered a
single acquirable asset?
2011 SMSF National Conference
Current issue – single acquirable asset
• The ATO in the September NTLG meeting said:
– in cases where assets are for practical purposes indissociable
(inseparable), or where there is an incident ancillary asset of a very
small value, we will not treat the test in paragraph 67A(1)(a) as
violated.
• However, the ATO then said:
– we do not think that ... a strata title with an accessory car park ...
necessarily falls into a particular category. We would need to
consider the facts of a particular case to make a decision.
• Submissions have been lodged to suggest that an accounting
concept of an asset should be adopted.
• Overall, there is no definitive answer.
2011 SMSF National Conference
Current issue – single acquirable asset
• In case where the test in s67A(1)(a) is not satisfied, multiple
borrowings are required.
Practically, what should clients do?
• Before signing contract, check to see if property is spread over
multiple titles (especially relevant for apartments, commercial
land and farms)
• If it is, ask:
– Will the financier lend on multiple loans (ie one for each title)?
– Will there be time before settlement to seek SMSF specific advice
from the ATO? If advice is negative, can SMSF settle without
borrowings?
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Current issue – improvements
• Distinction of repairs v improvements
• Consider the following:
– The trustee of the David Super Fund acquires a property under s 67A.
– The ceiling is in a state of disrepair. To restore the ceiling to its original
condition would have cost $603.
– The trustee instead wants to replace the ceiling with a new one of a
different design and better material for a cost of more than $3,000.
• Could a borrowing under s 67A be used to fund this new ceiling?
• The new ceiling is an improvement and not a repair (Western
Suburbs Cinemas Ltd (1952) 86 CLR 102). The borrowing under
s67A could not be used to fund this new ceiling.
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Current issue – improvements
• Assume an SMSF has $600,000 of cash and wants to buy
$1 million of real estate. It plans to apply $400,000 of its
cash to the purchase (borrow $600,000) and then pay for
$200,000 of capital improvements.
• Can this be done using a limited recourse borrowing
arrangement?
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Current issue – improvements
• Arguably a contravention of the charging prohibition. ATO
stated on 27-5-2010:
– SMSF trustees must not attach an existing fund asset to the real property or
otherwise subject an existing fund asset to a charge under the arrangement.
• More importantly, the ATO view is that the improved asset
constitutes a replacement asset, which would not be allowed
under the new limited circumstances where assets can be
replaced. The EM at para 1.29 states that circumstances not
permitting a replacement asset include:
– the replacement by way of improvement of real property
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Current issue – nature of holding trust
• The ATO, in the 7-9-2010 NTLG minutes stated that the
holding trust is not a bare trust, namely that:
– a holding trust .. that has a feature that the holding trust
trustee has granted a charge over the land (the acquirable
asset) to the lender … is not strictly a bare trust for that reason
alone.
• This raises uncertainty regarding the CGT, GST and
stamp duty concessions associated with the holding
trust being a bare trust.
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Current issue – off the plan
• Off the plan property purchases utilising SMSF borrowings are still
an area of uncertainty despite the large scale of this market
• In the 7-9-2010 NTLG minutes, the ATO’s stance on the issue is that:
– Without more details about the limited recourse borrowing
arrangement in mind we are not able to give a definitive answer.
• ATO did give indication that a situation where the borrowing
commenced after the apartment is completed, and title
registered, would be more likely to comply.
2011 SMSF National Conference
Current issue – off the plan
• Two options for potential off the plan purchasers:
– Apply to the ATO for SMSF specific advice and hope for a
positive reply in time
– Proceed with the transaction and bear the risk of uncertainty.
• There may be a concern that the property is improved
while it is owned by the SMSF.
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Current issue – title transfer
• ATO’s view is that the asset cannot remain in the holding trust
once the loan is paid off as the holding trust will no longer satisfy
the in-house asset exception in s71(8).
• Thus, the status of the holding trust is critical. Arguably a bare trust
is not a trust and therefore should not invoke the in-house asset
rules. However, not all SMSF borrowing arrangements are
documented as a bare trust nor in the same way.
• Further, generally stamp duty exemptions only apply when
property is transferred from an apparent purchaser (custodian
trustee) to a real purchaser (SMSF trustee), if all the money for the
asset is paid by the real purchaser being the SMSF (apart from
SA).
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Current issue – title transfer
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Case study:
Mr and Mrs Smith come to you on a Monday morning and share their
news that they have been successful at purchasing a property at
auction over the weekend, through their SMSF. The purchase was
unexpected, so Mr Smith paid the deposit with a cheque from his
personal account. Advise.
Mr and Mrs Smith have a number of options:
– Contact the real estate agent and arrange for his personal cheque to be
refunded and a new cheque drawn from the fund’s account.
– Journalise the payment by Mr Smith as a contribution (a deed may help
support this).
Generally, there are ways of rectifying the situation above. Clients should
be aware that unnecessary dialogue with their local state revenue office
may occur as a result.
2011 SMSF National Conference
Recent ATO IDs
ATO IDs 2010
• 162 — borrowing from a related party on terms favourable
to the self managed superannuation fund
• 169 — refinancing
• 170 — third party guarantee
• 172 — joint investors
• 184 — capitalisation of interest
• 185 — charge
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ATO ID 2010/162 — Low interest loan
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Does an SMSF contravene s109 SISA if it borrows money from a related
party on terms favourable to the SMSF compared to normal arm’s length
terms?
No. The terms cannot be more favourable to the related party than
would have been the case had the parties been dealing at arm’s
length, but there is no contravention of s109 if the terms are more
favourable to the SMSF.
Risk that a concessional loan may be treated as a contribution.
Example for discussion: an SMSF trustee obtains a borrowing at 4% from a
related family trust (market rate is 10%). This 6% discount could result in
excess contributions tax.
2011 SMSF National Conference
ATO ID 2010/170 — Guarantees
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Can a borrowing by an SMSF satisfy the requirements of former
s67(4A) where a related party of the SMSF has given the lender a
personal guarantee as part of the arrangement?
Yes, a borrowing arrangement that includes a guarantee to the
lender by a related party of the SMSF can satisfy s 67(4A).
Unless varied by the express terms of the guarantee, a guarantor will
generally have rights at common law and in equity against the
principal debtor, being the SMSF trustee, to recover amounts paid in
satisfaction of the obligations under the guarantee. This may include
interest and costs and in some circumstances, damages. The
recourse of the guarantor is therefore not necessarily restricted to the
asset which is the subject of the arrangement.
2011 SMSF National Conference
ATO ID 2010/170 — Guarantees
• When s 67(4A) applied as a borrowing exception, the rights
of the guarantor did not cause an arrangement to fail to
meet the requirements of the SISA.
• However, from 7 July 2010, s 67A requires guarantor’s rights
to be limited to the asset acquired with the borrowing. It
follows that guarantor’s rights must be limited; otherwise the
borrowing exception will not be satisfied and the fund will
be in contravention of s67.
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ATO ID 2010/172 — Joint investors
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Did the trustees of two SMSFs who jointly borrowed involving a single
holding trust, contravene s 67(1)?
Yes.
Scenario: In this arrangement, the two trustees held the property as
tenants in common through a single bare trust. As such, each trustee
only had a partial interest in the property (and no opportunity to
acquire the whole asset upon payment of their interest).
It follows that if two SMSF trustees were to buy real estate as tenants
in common, using separate bare trusts, this may be allowable.
However the practical barriers associated with such a structure may
be hard to overcome (such as bank lending).
2011 SMSF National Conference
New tax and licensing laws
• Draft Corporations Regulations amendment, which will
require AFSLs to extend to derivatives in order for
advisers to provide a financial service in relation to an
arrangement relating to the acquisition of an asset
under s 67(4A) of the SISA.
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The End
• Summary:
– SMSF borrowing – be aware and manage these risks
– Monitor developments & ensure your suppliers are also on top
of the changes
– Make sure your covered from a risk management viewpoint
• Questions
• Feedback forms
2011 SMSF National Conference