Self Managed Superannuation Funds (SMSFs) – Borrowing Rules

Tax & Superannuation

By Robert O’Keefe
September 16, 2015

This update provides a summary of the conditions that must be satisfied by an SMSF when borrowing to fund the purchase of real estate (and certain other assets).


Background
As at 30 June 2014, there were 534,176 SMSFs with over 1 million members. In the last 4 years the net number of SMSFs established was between 26,000 and 33,000 per annum.

Superannuation Funds are subject to the Superannuation Industry (Supervision) Act 1993 (“SIS Act”) and regulations.

Borrowing by SMSFs
The rules relating to borrowing by SMSFs are contained in sections 67A and 67B of the SIS Act. Since 30 June 2012 borrowing by SMSFs has increased from $2.4 billion to $8.7 billion as at 30 June 2014.

Why has there been an increase in the level of SMSF borrowing?

  • Introduction of new rules allowing SMSF borrowing in September 2007 and the later revision of those rules to clarify uncertainties associated with the earlier legislation.
  • The gradual acceptance by banks and lending institutions of SMSF borrowing arrangements.
  • Clients incorporating geared property as part of their SMSF’s investment strategy.
  • The end of the GFC and an increased willingness to borrow to fund asset acquisitions.
  • Widespread marketing in recent years by property developers aimed at using SMSF borrowing rules to access funds in SMSFs for the purchase of investment property.

What are the SMSF borrowing rules under section 67A of the SIS Act?

The conditions to be satisfied by an SMSF when borrowing are also issues that will need to be considered by a lender (whether the lender is a bank or a related party).

Assets that can be acquired by the SMSF with borrowed funds

  • Acquirable asset: The asset being purchased by the SMSF with the borrowed funds must be an asset that the SIS Act permits a SMSF to acquire. For example, a SMSF cannot purchase an asset from a member (or a related party) unless that asset is business real property or is a listed security. Consequently an SMSF could not purchase residential property from a member or a related party.
  • “Single acquirable asset”: The asset must be a “single acquirable asset”. There have been a number of Rulings by the ATO on what constitutes a “single acquirable asset”. For example, if a SMSF was to use borrowed funds to purchase a commercial or residential property where the car park is on a separate Title(s), the question arises as to whether the fund is acquiring a single acquirable asset or multiple assets. This issue also arises where the property comprises farm land over multiple titles or business premises constructed over multiple titles..
  • Acquisition costs only: The borrowed funds can only be used for the purchase of the asset and associated acquisition costs (borrowing costs, stamp duty, legal costs etc). The SMSF cannot borrow funds to redevelop or improve the property.
  • Shares: A borrowing arrangement could be entered into to enable the SMSF to purchase listed securities. However, the requirement that the asset being purchased with borrowed funds must be a “‘single acquirable asset” presents an issue when purchasing a parcel of shares. The SIS Act applies to a “collection of assets” in the same way as to a single acquirable asset provided, first, the assets in the collection have the same market value as each other and, secondly, the assets in the collection are identical to each other. A “collection of assets” could include a portfolio of shares of the same class in a single listed company.

A separate trust must be established to hold the asset on behalf of the SMSF
The single acquirable asset must be held by the trustee of a separate trust on behalf of the SMSF. These separate trusts are commonly referred to as Bare Trusts, Custodian Trusts or Property Trusts. The trustee of this trust must transfer legal title to the property to the SMSF trustee once the loan has been repaid. Under the terms of the trust deed, the bare trustee is directed to grant a mortgage over the property to the lender.

Limited recourse borrowing arrangements (LRBA)
Any loan agreement between the lender and the SMSF must, in the event of a default under the loan, limit the lender’s recourse to the single acquirable asset. The lender muat have no recourse to any other SMSF assets. The lender’s security will be a mortgage granted by the trustee of the bare trust over the property.

Personal Guarantees
A lender will usually require the SMSF members (or other related parties) to give personal guarantees securing repayment of the loan. This exposes the personal assets of those individuals giving the guarantees. Under the SIS Act, a guarantor’s ability to recover from the SMSF under their right of subrogation is also limited only to the “acquirable asset”.

There are also issues arising under the National Credit Code which will limit the effectiveness of personal guarantees in some cases.

How Wisewould Mahony can assist clients in SMSF borrowing arrangements

  1. Advising clients intending to buy a property through their SMSF on the contract of sale and the requirements for SMSF loans.
  2. Advising clients who need to have their SMSF Trust Deed checked for an appropriate power to borrow and the establishment of the custodian trust before they approach their bank or other financier.
  3. Drafting appropriate loan agreements complying with the LRBA rules (including mortgages) for clients who intend to borrow from a SMSF member (or related party).
  4. Advising clients on income tax issues (eg, Division 7A) where the proposed loan is from a company or other entity associated with the SMSF members.
  5. Advising banks and other lenders on SMSF loan requirements and drafting loan agreements which comply with the LRBA rules.
    Advising lenders regarding the existence of appropriate borrowing powers in the SMSF Trust Deed of the intending SMSF borrowers.
  6. Providing solicitor’s certificates and advice to persons giving personal guarantees to banks in relation to SMSF loans.

For more information on SMSF borrowing rules or any other SMSF-related matter, please contact Robert O’Keefe.