SMSF Technical Education & Strategies

Borrowing in your SMSF

A core issue of DIY / Self Managed Superannuation has always been that borrowing inside your SMSF was prohibited, except in very limited circumstances. Now whilst these borrowing prohibitions are still in place, a recent development has in fact opened up a certain type of borrowing that is now allowed inside your SMSF.

This issue originally came to a head years ago with the Telstra floats, where the stock was offered via installments. That is, you paid for part of the stock now, and part later, such that there appeared to be an underlying borrowing. This caused debate as to whether installment warrants in general were OK for SMSF's. The ATO at the time issued a ruling saying their view was that there was no borrowing in an installment warrant. However in 2007, they reversed this and issued a new ruling saying there was in fact a borrowing in these arrangements. However given the wide use of installment warrants up to that point, the Government decided to amend the legislation to continue to allow this type of investing.

Thus, the SIS act was amended to allow trustees of a SMSF to borrow in specific circumstances. In July 2010, the SIS Act was further amended to bring some clarity around some issuse that had cropped up in the meantime. Thus, a SMSF may borrow where it satisfies all the following conditions:

- the borrowed money can only be used to acquire a single asset, or a collection of identical assets that have the same market value They are all treated as a single asset and are called the ‘acquirable asset’ . These can only be assets that the fund is not otherwise prohibited from acquiring.

- the borrowed money can be applied to expenses incurred in connection with the borrowing or acquisition (e.g. loan establishment costs, stamp duty etc), or expenses incurred in maintaining or repairing the acquirable asset.

- borrowed money can be applied to improving an acquirable asset (such as renovations) however these improvements must not change the fundamental nature of the asset (e.g. a 4 bedroom home cannot turn into a duplex).

- the acquirable asset is held on trust (the holding trust). The SMSF trustee receives a beneficial interest in the asset
and has the right to acquire legal ownership of the acquirable asset by making one or more payments after acquiring the beneficial interest.

- the lender or any other person under the arrangement only has recourse against the SMSF trustee limited to rights relating to the acquirable asset. This limitation applies to rights directly or indirectly relating to a default on the borrowing and related charges or directly or indirectly relating to the SMSF trustee's rights in respect of the acquirable asset (for example, rights to income from the asset).

- the acquirable asset can not be subject to a charge other than as provided in relation to the borrowing by the SMSF trustee.

- As long as it is not otherwise prohibited from acquiring it, the acquirable asset can be replaced by another acquirable asset, but only in very limited circumstances as listed in the super law.

A number of commercial SMSF borrowing products have been created in the market to fulfill the above requirements and enable SMSF trustees to borrow to invest. This diagram below is basically how it will look:

Source: Townsends Business & Corporate lawyers

Unfortunately however, not all is as simple as it seems.

The Traps of SMSF borrowing 

by Townsends Business & Corporate Lawyers

There are a number of issues that have, or have the potential to, cause problems for SMSF trustees and their advisers in completing a successful and fully compliant borrowing transaction.

Trap #1 - Failing to Understand the Lender’s Requirements
Trap #2 – Failing to Appoint a Champion
Trap #3 – Not Paying All the Purchase Price from the Fund
Trap #4 – Not Arranging the Stamping of the Bare Trust
Trap #5 – The Custodian as the Lender

The full article and explanation of these traps by Townsends lawyers can be found in the article The Traps of SMSF Borrowing.

The 15 steps in a typical SMSF borrowing

by Townsends Business & Corporate lawyers

The full article and explanation of the 15 steps by Townsends lawyers can be found in the article The 15 Steps in a Typical SMSF Borrowing.