IN THE BLACK The monthly business magazine of CPA Australia LEVERAGING SUPER MONEY FOR PROPERTY INVESTMENT Richard Friend Superannuation now provides taxpayers with an investment vehicle which provides the ultimate in tax arbitrage. This is because the “cost” of an investment made through a super fund can effectively be tax deductible, if funded through concessional contributions – at a 46.5% rate for those on the top tax bracket. Yet the income from that investment, and the gain/proceeds on sale, can be totally tax-free and fully accessible. The ability to live in retirement with a totally tax-free income stream is what changes the whole paradigm through which people look at super. No more worrying about RBLs and complicated pension structures. There are now only two things to worry about: • How to get as much money as you can into super, and then get it out again tax free. • What you do with it once it is in there. There has been a lot written about the contribution and benefit rules. But what this article deals with is the issue that many people are now grappling with: “I maximised all my contributions pre June, now what do I do with the money?!” In addition, while most people appreciate the value of leverage in enhancing the return on an investment, the ability to leverage is perceived as very limited in the superannuation environment. For many superannuants, the investment of choice is a direct investment in real property. Yet the cost of property and the inability of a fund to leverage an acquisition have meant that, for these people, they never have enough in their fund to acquire direct property. Yet there are a number of legitimate ways for a SMSF to have a leveraged investment in property. This article looks at two of those: investing via a unit trust and the use of an instalment contract. Use of unit trusts Unit trusts can be useful vehicles to leverage SMSF investments. There are still a number of ways that superannuation monies can be legitimately used to provide the “equity” for a geared investment (in particular, a property investment) through a unit trust. The following comments relate to the most common form of such an investment. Overview of in-house asset rules The key provisions which can operate to otherwise prevent a fund investing via a unit trust are the in-house asset rules. The rules provide that an investment by a SMSF in a related trust is an in-house asset – and a SMSF generally must not have in-house assets that exceed 5%, by value, of the fund’s assets. While the definitions in the legislation are quite complicated, if two or more SMSFs (assuming they are not funds of related family members) were to jointly invest in a unit trust, the unit trust will not be a related trust provided that: No one fund (either alone or together with associated entities such as family trusts) has more than 50% of the units; No one member controls, or has the power to appoint, the trustee; and The relevant individuals are not also partners in a partnership (eg partners in the same accounting firm). This is because individuals who are partners (in the tax law context) are deemed to be associated for these purposes. So this structure is particularly suited to groups of like minded SMSF investors who wish to pool their funds to provide equity for an investment acquisition, with the unit trust undertaking the borrowing. Once a Unit Trust is established under this structure, there is nothing in the in- house asset rules to prevent loans to, or investments in, the unit trust by any of the SMSFs (assuming the control does not change). Instalment contracts For those who do not want to co-invest with others, there is another way to obtain leverage without borrowing. While the legislation prohibits a super fund from borrowing money, consideration should be given to what actually constitutes the borrowing of money. APRA Circular II.D.4 outlines what constitutes a “borrowing” for SIS purposes and acknowledges that not all liabilities of a fund will be borrowings for super purposes. Rather, it states that, consistent with a long line of case law “a borrowing usually involves receiving a payment from someone in the context of a lender/borrower on the basis that it will be repaid” The Circular notes a number of forms of financial accommodation which do not constitute borrowings, and included is an instalment contract. While these have been common in the share market (the various Telstra floats essentially involved instalment contracts) they can also be used for property. This may be illustrated by an example: • SMSF enters into a contract to acquire a property at the current price but with settlement not due for 10 years (when title will pass) • The SMSF pays an initial instalment of 30% and has the choice as to when to pay further instalments • Vendor charges interest annually on the unpaid purchase price • SMSF gets possession from day one and so has ability to benefit from income from the property • SMSF can settle and on-sell at any time – and so gets full benefit of capital growth In this scenario, the super fund has not borrowed, as the term is used in the SIS Act. Further, even if the owner had mortgaged the property, the super fund has not itself given a charge over any of its assets. The super fund’s asset is not the property itself, but its rights under the contract. Thus, this form of instalment contract is able to be entered into by a SMSF. If the property being acquires is commercial property, the SMSF can acquire the property from a related party. However, if a SMSF wishes to acquire residential premises, it cannot acquire such property from a related party. However, if an arm’s length vendor is prepared to offer instalment terms, there is no reason why a SMSF could not acquire a residential property under these terms. While such contracts are not currently common in the market, it is expected that they will proliferate in the coming years as all the new money in SMSFs looks for a home. One example of a structure which is currently on offer in the market place is the Superannuation Property Instalment (SPI) Plan being offered by Babcock & Brown. This facility allows a SMSF to acquire selected residential properties under an instalment contract which allows the purchaser up to 10 years to pay the full purchase price but gives the SMSF the full benefit of income and capital growth from the time of entering into the contract. Thus, the SPI Plan effectively allows a super fund to leverage an investment in residential property – and use tax deductible super contributions to pay off property. This use of instalment contracts to acquire property is not negative gearing - it is a lot better! In addition, an instalment contract offers the following advantages over using a unit trust to leverage a property investment: • No requirement to have another unrelated party involved in the investment, with all the attendant potentials for conflict • No need to incorporate new entities, such as the unit trust and a trustee company • An instalment contract does not require any external financiers with the potential need for personal guarantees or other forms of security • If using a unit trust, the structure must be monitored to ensure that no one super fund or its members ever gain control (and cause a breach of the in- house asset rules), and that the trust income is not classified as non-arm’s length income to the super fund. So SMSFs have lots of opportunities to leverage their investments, thereby maximising the after-tax return to the members. Published in In the Black, the monthly business magazine of CPA Australia, 2007.
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