Superannuation Funds –
Borrowing Exception Superannuation Borrowing Rules Before 24 September 2007
Prior to the 27th September 2007, section 67 of the Superannuation Industry (Supervision) Act 1993 (SIS) generally prohibited superannuation funds from borrowing or maintaining an existing borrowing. There were only a few limited exceptions to the general rule.
Superannuation Borrowing Rules After 24 September 2007
Prior to this date, superannuation funds were able to invest in what are know as “instalment warrants” consistent with longstanding administrative practice. The Australian Tax Office (ATO) and Australian Prudential Regulation Authority (APRA) reviewed these arrangements and concluded that instalment warrant products involved borrowing and as such were not an allowable investment. After due consideration the Federal Government of the day announced that with effect from 24 September 2007 they would legislate to allow the longstanding practice of superannuation funds investing in instalment warrants to continue.
Basic conditions
As mentioned above superannuation funds are now able to borrow to invest under a ‘non-recourse loan' facility, provided the following borrowing requirements are met:
• The borrowed money must be applied to acquire an asset (eg. property);
• The asset is one that a superannuation fund can acquire (for example a fund cannot borrow to acquire a residential property from a member);
• The asset is held on trust so that the superannuation fund acquires a beneficial interest in the asset;
• The superannuation fund acquires the legal interest by making one or more payments (know as instalments);
• The rights of the lender against the superannuation fund are limited to rights relating to the asset (non-recourse) .
The ATO has indicated that provided the ‘non-recourse loan' has been established within the legislative framework there will be no cause for concern.
As such monies can be lent by an external financier or a related party to a superannuation fund – the key requirement is that all aspects of the transaction are based on commercial arms length terms (i.e. price, interest rates etc).
Benefits
Some of the benefits of entering into a geared superannuation strategy include
• Unlocking significant amounts of cash
• Rental income from the property can be used to help repay the loan
• Net income from the property and capital gains will be taxed at concessional tax rates of between 0% and 15%; and
• Member superannuation balances are increased leading to larger tax free income streams being available when members turn 60
Issues to consider
Prior to undertaking a geared superannuation strategy the superannuation fund liquidity requirements and whether the existing deed allows the superannuation fund to borrow need to be considered. Transaction costs including stamp duty and capital gains tax also need to be considered particularly if the asset being transferred is owned by a member or related party of the superannuation fund.
The costs to set-up and maintain a geared superannuation strategy also need to be considered. There is also the possibility of higher interest rates due to the non-recourse nature of the loan.
Another consideration is the superannuation fund's investment strategy and whether or not a gearing strategy fits within the investment conditions of the fund. Also it is important to ensure the sole purpose test is not breached when entering into such an arrangement.
The above is only a brief summary of the types of issues which need to be considered before entering into a geared superannuation strategy.
Opportunities
Some of the potential opportunities that have arisen as a result of the above change in legislation include:
• Converting non-deductible debt to deductible debt
• To assist in combating Division 7A issues or to clean up a grandfathered leveraged unit trust already owned by the superannuation fund
• Moving pre-CGT property into a superannuation fund using a geared superannuation strategy to free up cash
Conclusion
This change in legislation has presented a huge opportunity for small businesses to use self managed superannuation fund wealth to fund business property acquisitions. We would warn however that the illegitimate use of this structure may cause the government to rethink its policy in this area, and potentially spoil the advantages for those who legitimately adopt this strategy for sound retirement reasons.
Disclaimer: This periodical is general in nature and its brevity could lead to misrepresentation. No responsibility can be accepted for those who act without first consulting and obtaining specific advice.
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