SMSF Technical Education & Strategies

 

The 15 steps in a typical SMSF borrowing....and other issues.

by Peter M Townsend BA, LLB, FAICD, FCLA
Townsends Business and Corporate Lawyers.

 

Typically a borrowing by an SMSF has the following steps:

1 Determine (often with the help of the fund’s accountant or financial planner) that borrowing would be an appropriate strategy to leverage investment

 

2 Check the trust deed to ensure trustee has power to borrow, grant security & allow assets to be held by custodians/nominees for the trustee (if not, amend the trust deed)

 

3 Check the investment strategy to ensure it allows for the acquisition of the investment asset and permits borrowing for that purpose (if not, amend the investment strategy)

 

4 Source the asset for purchase, negotiate the price and reach agreement with the vendor

 

5 Finalise borrowing arrangements with the lender including in-principle loan approval

 

6 Determine who is to be the custodian – if a new company, purchase the new company

 

7 Custodian resolves in writing to act as custodian for the super fund trustee in the purchase of the asset

 

8 Super fund trustee resolves in writing to purchase the asset and to appoint the custodian to act for the super fund trustee as bare trustee of the bare trust

 

9 Signing of the purchase contract by the custodian (note: not the super fund trustee)

 

10 Super fund trustee provides all the deposit money for the purchase (should come directly from the super fund’s account)

 

11 Custodian and super fund trustee sign the bare trust deed

 

12 Super fund trustee signs all loan documents with the lender (note: super fund trustee is the borrower)

 

13 Purchase of the asset is completed using only money coming from the super fund’s account or from the loan by the lender

 

14 The bare trust deed is submitted to the NSW Office of State Revenue for payment of stamp duty of $50 (plus $10 for each copy)

 

15 When the loan is eventually repaid the asset can be transferred from the custodian to the super fund trustee for nominal stamp duty provided the bare trust deed has been stamped already.

 

Popular variations on the theme

If the loan from the bank is extended to a third party (eg a member, a family trust associated with the members or other relatives or associates) which then on-lends to the SMSF, the bank loan can be refinanced without disturbing the loan to the SMSF.

If the loan comes from the family trust then there may be internal leveraging of the asset position of the family group.
Note that any loan from an associate of a fund member must be at market rates. Higher than market rates may breach the super fund trustee’s duty to the members and may breach the sole purpose test while lower than market rates may breach the in-house asset rules.

 

Guarantees

In a Question & Answer document about Super Gearing arrangements published on its website the ATO say that personal guarantees are acceptable for super gearing arrangements entered into after 23 September 2007.

However different issues arise for transactions entered into after 6 July 2010.

• Personal guarantees entered into after 23 September 2007 and before 7 July 2010:

The lender’s recourse against the SMSF trustee must be limited to asset acquired under the super gearing arrangement. A third party may put up their own asset(s) as a means of providing additional security to the lender. The ATO say that “It is not required that a third party guarantor waive their usual rights of indemnity against the principal debtor (the SMSF trustee) in the event of a call on the guarantee. However, SMSF trustees should carefully consider the risks to the assets of the SMSF (other than the asset being acquired under the limited recourse borrowing arrangement) that an unlimited guarantee might represent. The rights of indemnity given in favour of a guarantor may be excluded or limited by the express terms of the guarantee.”

• Personal guarantees entered into after 6 July 2010:

The lender’s recourse against the SMSF trustee must be limited to asset acquired under the super gearing arrangement. The lender’s recourse and any one else against the SMSF trustee “in connection with, or as a result of, a default on the borrowing (either directly or indirectly) must be limited to rights relating to the asset that is being acquired under the arrangement.
“…any guarantor must not have general rights of indemnity against the principal debtor (the SMSF trustee) that might crystallise in the event of a call on the guarantee. However, the guarantor may have rights of subrogation of the lender’s rights (that is, the right to exercise the lender's limited rights of recourse to the asset being acquired under the arrangement) that might crystallise in the event of a call on the guarantee.

 

Personal Guarantees and Contributions

The ATO believe that if a guarantor makes a payment to a lender “under an arrangement where they have foregone their usual rights of indemnity against the principal debtor (the SMSF trustee) in respect of the guarantee, this is a contribution to the SMSF if it satisfies a liability of the SMSF. This might happen, for example, if the guarantor paid the borrowing and the acquirable asset was transferred to the SMSF trustee under the arrangement.”

However it will not be a contribution “if the SMSF trustee has exercised a right to ‘walk away’ from the arrangement (and has lost the acquirable asset to the lender) and has no further liability, but the lender still exercises a right to call on the guarantee for a shortfall after disposal of the original asset.” Further details are available in the ATO’s Tax Ruling 2010/01.

 

While Townsends Business & Corporate lawyers believe that the information contained herein is reliable, no warranty is given to the accuracy and persons who rely on it do so at their own risk. This information is intended to provide background information only and does not purport to make any recommendation upon which you may reasonably rely without taking specific advice. In particular, it should not be considered financial product advice for the purposes of the Corporations Act. If you would like more information on this article or any other SMSF information provided by Townsends, please contact them at info@townsendslaw.com.au