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Presentation - Instalment warrant strategies - Financial Review


									             Session 4B:
Instalment Warrant Strategies
(Limited Recourse Borrowing)
          Daniel Butler
        Director, DBA Lawyers

                                2011 SMSF National Conference
• Introduction to SMSF Borrowing
• Comparison between the old s 67(4A) and current ss 67A and 67B
  of the SISA
• Unresolved Issues
   –   concept of single acquirable asset
   –   true nature of holding trust
   –   off the plan purchases
   –   transfer of title
• Recent ATO IDs
• Tax and licensing rules
• Summary

                                            2011 SMSF National Conference
•   History: SMSF investment in instalment warrants (IWs)
     – IW = interest in a trust over an underlying asset.
     – Investor makes instalment payments and then acquires asset.
     – Typically shares, eg, 40% of T3 investors reportedly super funds.
•   Super funds prohibited from borrowing: s 67
•   ATO, APRA: concerned that IWs like a ‘borrowing’.
•   Government announced plans to clarify the law.
•   Section 67(4A):
     – applied from 24 Sep 2007 to 6 July 2010
     – allows trustee to borrow to buy any asset a fund could normally buy
     – not strictly an IW: allows direct borrowing by trustee
•   Sections 67A and 67B
     – Introduced with effect from 7 July 2010
     – Aimed to clarify s67(4A), but still unresolved issues
                                                              2011 SMSF National Conference
Borrowing: typical structure
                 SMSF provides
                  purchase $ to
                 security trustee
                                                                 $ repayments
  Vendor                                   SMSF                                         lender
                                                                     $ loan

    $ rent or                                                    role should be
  other income                    Security trustee/                                                  No mortgage or
                                                                     minimal                           any other
                                    bare trustee/
                                custodian/DIT trustee                                                   recourse

                                                 holds legal title                               Other SMSF
                                asset being acquired                                                assets
                                  (eg, real estate)

                                                                                  2011 SMSF National Conference
Section 67(4A) — features
• Effective from 24 Sept 2007 to 6 July 2010 inclusive
• Borrowing must have the following features:
   – Money applied for the acquisition of an asset
   – Asset must be one the SMSF could invest in directly
   – Asset (or replacement asset) held on trust so SMSF acquires
     beneficial interest in asset (or replacement asset)
   – SMSF has right to acquire legal ownership of asset (or
     replacement asset) by making one or more payments
   – Lender’s rights against SMSF trustee for default limited to
     underlying asset (or replacement asset)

                                               2011 SMSF National Conference
Sec 67A and s 67B – six major changes
•   Effective from 7 July 2010. Contains SIX major changes:
•   Headed ‘Limited recourse borrowing arrangement’ — no mention of IWs (1)
•   Borrowing must have the following features:
    – Money applied for the acquisition of an ‘single acquirable asset (2)’
        • can include refinancing (3)
        • can include repairs and maintenance but not improvements (4)
        • can include borrowing to pay for conveyancing fees, stamp duty, etc
    – Acquirable asset held on trust so SMSF acquires beneficial interest in asset
    – SMSF has right to acquire legal ownership of asset (or replacement asset) by
        making one or more payments
    – Rights of lender and any other person (5) against SMSF trustee for default
        limited to acquirable asset [ie, relevant for guarantees]
•   There has been detailed clarification as to when a single acquirable asset can be
    replaced (6)

                                                            2011 SMSF National Conference
Current issue – single acquirable asset
• An acquirable asset is an asset that is:
   – not money (whether Australian currency or currency of
      another country); and
   – not prohibited by the SISA, SISR or any other law (eg, state
      trustee legislation).
• A collection of identical assets with the same market value
  (fungible assets) is treated as a single acquirable asset, eg, 100
  ordinary BHP shares.
• But is a property which is spread over multiple titles considered a
  single acquirable asset?

                                                 2011 SMSF National Conference
Current issue – single acquirable asset
• The ATO in the September NTLG meeting said:
   – in cases where assets are for practical purposes indissociable
     (inseparable), or where there is an incident ancillary asset of a very
     small value, we will not treat the test in paragraph 67A(1)(a) as
• However, the ATO then said:
   – we do not think that ... a strata title with an accessory car park ...
     necessarily falls into a particular category. We would need to
     consider the facts of a particular case to make a decision.
• Submissions have been lodged to suggest that an accounting
  concept of an asset should be adopted.
• Overall, there is no definitive answer.

                                                       2011 SMSF National Conference
Current issue – single acquirable asset
• In case where the test in s67A(1)(a) is not satisfied, multiple
  borrowings are required.

Practically, what should clients do?
• Before signing contract, check to see if property is spread over
  multiple titles (especially relevant for apartments, commercial
  land and farms)
• If it is, ask:
    – Will the financier lend on multiple loans (ie one for each title)?
    – Will there be time before settlement to seek SMSF specific advice
      from the ATO? If advice is negative, can SMSF settle without

                                                     2011 SMSF National Conference
Current issue – improvements
• Distinction of repairs v improvements
• Consider the following:
   – The trustee of the David Super Fund acquires a property under s 67A.
   – The ceiling is in a state of disrepair. To restore the ceiling to its original
     condition would have cost $603.
   – The trustee instead wants to replace the ceiling with a new one of a
     different design and better material for a cost of more than $3,000.
• Could a borrowing under s 67A be used to fund this new ceiling?
• The new ceiling is an improvement and not a repair (Western
  Suburbs Cinemas Ltd (1952) 86 CLR 102). The borrowing under
  s67A could not be used to fund this new ceiling.

                                                          2011 SMSF National Conference
Current issue – improvements
• Assume an SMSF has $600,000 of cash and wants to buy
  $1 million of real estate. It plans to apply $400,000 of its
  cash to the purchase (borrow $600,000) and then pay for
  $200,000 of capital improvements.
• Can this be done using a limited recourse borrowing

                                           2011 SMSF National Conference
Current issue – improvements
• Arguably a contravention of the charging prohibition. ATO
  stated on 27-5-2010:
   – SMSF trustees must not attach an existing fund asset to the real property or
     otherwise subject an existing fund asset to a charge under the arrangement.
• More importantly, the ATO view is that the improved asset
  constitutes a replacement asset, which would not be allowed
  under the new limited circumstances where assets can be
  replaced. The EM at para 1.29 states that circumstances not
  permitting a replacement asset include:
   – the replacement by way of improvement of real property

                                                            2011 SMSF National Conference
Current issue – nature of holding trust
• The ATO, in the 7-9-2010 NTLG minutes stated that the
  holding trust is not a bare trust, namely that:
   – a holding trust .. that has a feature that the holding trust
     trustee has granted a charge over the land (the acquirable
     asset) to the lender … is not strictly a bare trust for that reason
• This raises uncertainty regarding the CGT, GST and
  stamp duty concessions associated with the holding
  trust being a bare trust.

                                                   2011 SMSF National Conference
Current issue – off the plan
• Off the plan property purchases utilising SMSF borrowings are still
  an area of uncertainty despite the large scale of this market
• In the 7-9-2010 NTLG minutes, the ATO’s stance on the issue is that:
   – Without more details about the limited recourse borrowing
     arrangement in mind we are not able to give a definitive answer.
• ATO did give indication that a situation where the borrowing
  commenced after the apartment is completed, and title
  registered, would be more likely to comply.

                                                  2011 SMSF National Conference
Current issue – off the plan
• Two options for potential off the plan purchasers:
   – Apply to the ATO for SMSF specific advice and hope for a
     positive reply in time
   – Proceed with the transaction and bear the risk of uncertainty.

• There may be a concern that the property is improved
  while it is owned by the SMSF.

                                               2011 SMSF National Conference
Current issue – title transfer
• ATO’s view is that the asset cannot remain in the holding trust
  once the loan is paid off as the holding trust will no longer satisfy
  the in-house asset exception in s71(8).
• Thus, the status of the holding trust is critical. Arguably a bare trust
  is not a trust and therefore should not invoke the in-house asset
  rules. However, not all SMSF borrowing arrangements are
  documented as a bare trust nor in the same way.
• Further, generally stamp duty exemptions only apply when
  property is transferred from an apparent purchaser (custodian
  trustee) to a real purchaser (SMSF trustee), if all the money for the
  asset is paid by the real purchaser being the SMSF (apart from

                                                    2011 SMSF National Conference
Current issue – title transfer
•   Case study:
•   Mr and Mrs Smith come to you on a Monday morning and share their
    news that they have been successful at purchasing a property at
    auction over the weekend, through their SMSF. The purchase was
    unexpected, so Mr Smith paid the deposit with a cheque from his
    personal account. Advise.
•   Mr and Mrs Smith have a number of options:
     – Contact the real estate agent and arrange for his personal cheque to be
       refunded and a new cheque drawn from the fund’s account.
     – Journalise the payment by Mr Smith as a contribution (a deed may help
       support this).
•   Generally, there are ways of rectifying the situation above. Clients should
    be aware that unnecessary dialogue with their local state revenue office
    may occur as a result.

                                                          2011 SMSF National Conference
Recent ATO IDs
ATO IDs 2010
• 162 — borrowing from a related party on terms favourable
  to the self managed superannuation fund
• 169 — refinancing
• 170 — third party guarantee
• 172 — joint investors
• 184 — capitalisation of interest
• 185 — charge

                                         2011 SMSF National Conference
ATO ID 2010/162 — Low interest loan
•   Does an SMSF contravene s109 SISA if it borrows money from a related
    party on terms favourable to the SMSF compared to normal arm’s length
•   No. The terms cannot be more favourable to the related party than
    would have been the case had the parties been dealing at arm’s
    length, but there is no contravention of s109 if the terms are more
    favourable to the SMSF.
•   Risk that a concessional loan may be treated as a contribution.
•   Example for discussion: an SMSF trustee obtains a borrowing at 4% from a
    related family trust (market rate is 10%). This 6% discount could result in
    excess contributions tax.

                                                       2011 SMSF National Conference
ATO ID 2010/170 — Guarantees
•   Can a borrowing by an SMSF satisfy the requirements of former
    s67(4A) where a related party of the SMSF has given the lender a
    personal guarantee as part of the arrangement?
•   Yes, a borrowing arrangement that includes a guarantee to the
    lender by a related party of the SMSF can satisfy s 67(4A).
•   Unless varied by the express terms of the guarantee, a guarantor will
    generally have rights at common law and in equity against the
    principal debtor, being the SMSF trustee, to recover amounts paid in
    satisfaction of the obligations under the guarantee. This may include
    interest and costs and in some circumstances, damages. The
    recourse of the guarantor is therefore not necessarily restricted to the
    asset which is the subject of the arrangement.

                                                     2011 SMSF National Conference
ATO ID 2010/170 — Guarantees
• When s 67(4A) applied as a borrowing exception, the rights
  of the guarantor did not cause an arrangement to fail to
  meet the requirements of the SISA.
• However, from 7 July 2010, s 67A requires guarantor’s rights
  to be limited to the asset acquired with the borrowing. It
  follows that guarantor’s rights must be limited; otherwise the
  borrowing exception will not be satisfied and the fund will
  be in contravention of s67.

                                             2011 SMSF National Conference
ATO ID 2010/172 — Joint investors
•   Did the trustees of two SMSFs who jointly borrowed involving a single
    holding trust, contravene s 67(1)?
•   Yes.
•   Scenario: In this arrangement, the two trustees held the property as
    tenants in common through a single bare trust. As such, each trustee
    only had a partial interest in the property (and no opportunity to
    acquire the whole asset upon payment of their interest).
•   It follows that if two SMSF trustees were to buy real estate as tenants
    in common, using separate bare trusts, this may be allowable.
    However the practical barriers associated with such a structure may
    be hard to overcome (such as bank lending).

                                                     2011 SMSF National Conference
New tax and licensing laws
• Draft Corporations Regulations amendment, which will
  require AFSLs to extend to derivatives in order for
  advisers to provide a financial service in relation to an
  arrangement relating to the acquisition of an asset
  under s 67(4A) of the SISA.

                                         2011 SMSF National Conference
                          The End
• Summary:
  – SMSF borrowing – be aware and manage these risks
  – Monitor developments & ensure your suppliers are also on top
    of the changes
  – Make sure your covered from a risk management viewpoint
• Questions
• Feedback forms

                                             2011 SMSF National Conference

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