SMSF Technical Education & Strategies

The traps of SMSF borrowing

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

1 After a slow start in 2008, with many advisers still coming to grips with the change to the previous orthodoxy that superannuation funds could not borrow and the banks slowly developing their strategies and processes, SMSF borrowing became a mainstream strategy in 2009 with many funds availing themselves of the opportunity.

2 This short paper focuses on five so-called ’traps’ – issues that have, or have the potential to, cause difficulty for SMSF trustees and their advisers in completing a successful and fully compliant borrowing transaction.

3 This paper assumes a basic knowledge in the reader as to how the SMSF borrowing process works and the requirements of s.67(4A) of the SIS Act, which applied to super transactions entered into before 7 July 2010 and Sections 67A and 67B of that legislation which applies for transactions entered into on or after 7 July 2010.

4 These issues are not discussed in any particular order.

Trap #1 - Failing to Understand the Lender’s Requirements

5 A number of lenders have specific requirements and it is important to understand these before proceeding with the transaction. It is unwise to assume that this loan is like any other residential or commercial loan. Clearly it is not and lenders may have specific issues to deal with.

6 Examples of these issues include:
a. the fund’s deed must be reviewed by the bank and found to have all the necessary powers including the power to borrow, the power to grant security for a borrowing, the power to appoint an agent or bare trustee and so on

b. in cases of purchase from a related party, the purchase must be by contract and not simply transfer in order to satisfy s.109 SIS Act which requires arms-length dealings by a super fund trustee

c. the trustee must be a company

d. the members of the fund must adhere to a particular contributions program.

Trap #2 – Failing to Appoint a Champion

7 A borrowing transaction by an SMSF is not complex but it is substantial. There are many players who may be involved including (if an arms length purchase is being funded) the real estate agent, the vendor, the vendor’s solicitor, the fund’s conveyancing solicitor, the lender, the loan broker, the lender’s solicitor, the fund’s superannuation solicitor, the custodian, the fund’s accountant, the fund’s financial planner and the stamp duties office.

8 The process needs a champion – someone who drives the process on behalf of the fund. An investment/compliance transaction of this kind will go seriously wrong unless someone takes complete control. The property experts will ignore the investment/compliance issues and the investment/compliance experts will ignore the property issues.

9 Normally the champion would be the fund’s accountant or financial planner. Someone who understands the investment/compliance issues and yet appreciates that the property issues must be looked after as well.

10 Our experience is that if there is no champion then confusion reigns. Also for stamp duty reasons the transaction must be carried out in the right order and the failure to do that can lead to double duty. The Champion will understand the required order of proceedings and ensure that everyone sticks to that order, namely (in NSW)

· set up custodian
· sign trustee’s resolution
· sign custodian’s resolution
· complete contract with custodian as buyer
· arrange loan to the fund
· exchange contracts for the purchase
· execute the bare trust
· settle the purchase
· stamp the bare trust deed

11 If you don’t want to be the Champion then find someone who does and can.

Trap #3 – Not Paying All the Purchase Price from the Fund

12 In order to ensure that only nominal stamp duty is paid on the transfer from the bare trustee to the SMSF trustee once the loan has been repaid, it is necessary to have the bare trust stamped under the ‘apparent purchaser’ provisions of the Duties Act.

13 Essentially those provisions recognise that all the money used to acquire the property was provided by the ‘real purchaser’ who is the ‘real owner’ of the property rather than the party who appeared to buy the property (the ‘apparent purchaser’) who is simply the nominal owner. Then at the time of the transfer from the apparent purchaser to the real purchaser no actual beneficial interest in the property changes and the Duties Act therefore allows only nominal duty rather than full ad valorem duty.

14 To be eligible to use these provisions it is necessary that the real purchaser provide ALL the purchaser money. That’s ALL – not “most”, not “the vast majority”, not“almost all” and not “effectively all”, but rather ALL.

15 A number of cases have arisen where the client reached agreement with the vendor or the vendor’s agent and then paid a nominal ‘good faith’ deposit (between say $1,000 and $5,000) from their personal funds. The rest of the deposit came from the fund as did the settlement amount. When it came time to stamp the bare trust deed the fund could not satisfy the ALL provision because of that small amount. Make no mistake that the OSR will show no mercy.

16 Make sure that any good faith deposit is paid from the fund. If it can’t be then make sure that it is refunded by the fund to the payer as soon as possible – before exchange hopefully but before settlement absolutely.

17 If the problem has arisen then one way to resolve it is to treat the payment as a contribution to the fund. The usual rules will apply in respect of that contribution.

18 Alternatively it may be necessary for the loan to remain outstanding until the fund is ready to sell the property in which case the bare trustee will transfer the property direct to the buyer rather than to the SMSF trustee.

Trap #4 – Not Arranging the Stamping of the Bare Trust

19 Leaving the bare trust deed unstamped may be asking for trouble if the bare trustee ever wants to transfer the property to the SMSF trustee. It is therefore important to act at the time of the purchase of the property to have the bare trust deed stamped.

20 Delaying the stamping will make access to appropriate records difficult. The OSR requires evidence of the transaction and that the fund provided all the purchase money.

21 It is necessary to submit to the OSR a statutory declaration attaching

· a copy of the front page of the stamped contract (which evidences the parties to the transaction and the payment of duty on the purchase)
· copies of the fund’s bank statements showing the debits in relation to the payment of all the purchase monies – deposit and settlement amount
· copy of loan documents showing the loan details (this can be the bank’s loan offer letter); and
· a copy of the settlement sheet showing how the settlement figure was calculated and the cheques drawn on settlement which relates back to the figures on the bank statement.

22 If no action is taken to stamp the bare trust until years later then the ability to quickly and efficiently source these documents will have diminished significantly. Do it now while they are all readily available.

23 Of course the failure to pay duty may also be an offence under the Duties Act which gives rise to additional duty and fines. Professional advisers can be penalised if they aid and abet such failure.

Trap #5 – The Custodian as the Lender

24 This has been suggested as a way of saving money on a corporate custodian and where the loan to the fund is being made by a member.

25 Although prima facie the 5 essential criteria in an SMSF borrowing would be met if the lender became the custodian, an inherent problem arises under the terms of the bare trust. Under the bare trust the custodian is required to do as directed by the SMSF trustee. This is particularly relevant in relation to capital gains tax where the ability to call for the transfer of the property means that the fund is ‘absolutely entitled’ to the property and therefore no CGT is payable on the eventual transfer from
custodian to fund.

26 Being both custodian and lender gives rise to potential conflicts of interest. As bare trustee (and mortgagor) the custodian is required to deal with the property as directed by the fund. As lender (and mortgagee) the custodian has their own rights in respect of the property. The disparate set of rights held by the one party would be incompatible. We do not recommend this strategy.

Disclaimer: 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