Paper for Presentation at SPAA NC2011

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Instalment warrant strategies (limited recourse borrowing)
Seminar Paper for SPAA National Convention, 2011. By Daniel Butler, director and Nathan
Papson, lawyer, both of DBA Lawyers.
Introduction
This paper has been written in conjunction with the presentation by Daniel Butler at Session 4B at
the SPAA National Convention, 2011. The paper will broadly cover the following topics:
 a brief history of self managed superannuation fund (‘SMSF’) borrowing;
 key features of the SMSF borrowing structure including stamp duty considerations;
 an outline of the six key changes to SMSF borrow laws contained in s 67A of the
Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’);
 a practical guide to approaching some of the current uncertainties for SMSF borrowing; and
 a summary of some of the ATO IDs released in late 2010 on SMSF borrowing.
While the current SMSF borrowing laws provide an avenue of investment to SMSFs which was
not previously available, there are still many areas of the law which require clarification. This
paper will attempt to explore these areas in detail and provide practical solutions and suggestions
where possible.
1 A brief history of SMSF borrowing
Before 24 September 2007, the SISA contained a provision in s 67(1) which prohibited SMSFs
from borrowing. Borrowing was only limited in certain circumstances, such as to cover payments
to beneficiaries, payment of the superannuation surcharge, or cover settlement of a security
transaction.
The exception for SMSF borrowing was firstly introduced with effect from 24 September 2007
under the now repealed s 67(4A) of the SISA. The law was introduced in response to a high
proportion of SMSFs investing in ‘instalment warrant’ type arrangements in shares. These
investments broadly worked as follows:
 The SMSF bought the shares in a company, but the shares would be held on trust.
 The SMSF made instalment payments to the company, which typically reflected the time
value of money.
 The SMSF acquired the asset upon full payment of the shares.
The ATO and APRA were worried that this type of arrangement was, prima facie, similar to that of
a borrowing — namely the SMSF would acquire the shares and the payments made were similar
to that of a loan, with the interest component being deductible.
Perhaps the highest profile instalment warrant style share issue was the launch of Telstra T3
shares. Reportedly 40% of T3 investors were super funds. As such, it was in the Government’s
best interest at the time to amend legislation to allow for super funds to make such investments.
Hence, s 67(4A) came into effect.
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2. Section 67(4A) had effect from 24 September 2007 through to 6 July 2010. From 7 July 2010
onwards, the new ss 67A and 67B of the SISA have effect. These provisions were introduced in
an attempt to clarify the old legislation, as well as introduce clear limits to isolate the liabilities of
the asset being the subject of the borrowing from other fund assets.
The current legislation has given rise to a number of uncertainties, which require clarification from
the ATO. This paper will explore these uncertainties in greater detail later in the paper.
2 Key features of the SMSF borrowing structure and stamp duty implications
2.1 Typical borrowing structure
A typical structure for SMSF borrowing is shown below.
repayments
SMSF
loan
lender
custodian
rent or trust
other income trust’s role should
be minimal: for
holds legal title security interest
alone
asset
(eg, property,
shares, units)
Some of the key features of this typical transaction are:
 The actual borrowing is done by the trustee of the SMSF.
 The asset must be held on trust by a custodian trustee, with the trustee of the SMSF having
a beneficial interest in that trust.
 The custodian trustee is the legal holder of the asset purchased.
 The SMSF trustee will have the right to obtain legal ownership by making one or more
payments after acquiring the beneficial interest.
 If the SMSF trustee were to default on the loan contract with the lender, the lender’s rights
on default are limited to the asset which is the subject of the borrowing (ie, limited
recourse).
2.2 Stamp duty considerations
The initial purchase of real property gives rise to a stamp duty liability. Upon repayment of the
loan, the instalment warrant trustee generally transfers the property to the SMSF trustee.
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3. Whether this transfer at the end of the arrangement (ie, from the instalment warrant trustee to the
SMSF trustee) is subject to duty depends heavily on how the arrangement was entered into at the
start.
Accordingly, it is vital to be aware of any relevant stamp duty exceptions that might apply when
the property is transferred from the instalment warrant trustee to the SMSF trustee. Each
jurisdiction is different.
One relevant exception in Victoria, New South Wales, Australian Capital Territory, Western
Australia and Tasmania in respect of the transfer at the end of the arrangement is the ‘apparent
purchaser’ exception. Broadly, the apparent purchaser exception provides that property may be
transferred from an apparent purchaser (eg, instalment warrant trustee) to a real purchaser (eg,
the SMSF trustee) without significant stamp duty if the real purchaser provided the money for the
purchase.
Therefore it is vital that it can be demonstrated that:
 the SMSF trustee is the real purchaser;
 the instalment warrant trustee is a mere apparent purchaser; and
 the SMSF trustee provided all of the purchase moneys (including the deposit).
In light of this, there are several popular ways of completing the purchase contract. The exact
way depends on which jurisdiction the property is in and what the lawyer handling the
conveyance is most comfortable with.
One way that is popular in Victoria is to describe the purchaser as ‘<name of instalment warrant
trustee> as bare trustee for <name of SMSF trustee> ATF <name of SMSF>’.
Another way, which is popular in New South Wales, is to merely describe the purchaser as
‘<name of instalment warrant trustee>’ and then rely on other documentation to evidence the trust
relationship.
Again, the exact method used depends on which jurisdiction the property is in and what the
lawyer handling the conveyance is most comfortable with.
This also helps evidence that the real purchaser is the SMSF trustee and also helps to come
within the apparent purchaser exception.
It is also vital to be able to demonstrate that all of the purchase moneys came from the real
purchaser (ie, SMSF). This includes the deposit. This is best evidenced by bank statements.
The most common mistakes are:
 A different entity pays some of the purchase price. This usually happens where clients pay
the deposit personally.
 The client completes the purchase contract in a manner that does not give due regard to the
stamp duty exceptions at the end.
 The instalment warrant trustee and/or the SMSF trustee is not incorporated at the time of the
signing of the purchase contract.
None of these mistakes are fatal. Depending on the jurisdiction, there can be different solutions.
However, if the client has made any of these mistakes, financial planners should caution them
that proceeding with an SMSF borrowing might have some risk of additional stamp duty.
Recent interpretations by the ATO have potentially increased the risk of stamp duty being
payable on the subsequent transfer of the asset from the custodian trustee to the trustee of the
SMSF. These will be discussed later in this paper.
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4. 3 Six key changes to SMSF borrowing under the current s 67A of the SISA
3.1 Don’t say instalment warrant
The new legislation has essentially scrapped the term ‘instalment warrants’. The replacement
legislation refers to ‘limited recourse borrowing arrangements’. Advisers and practitioners should
become used to the new terminology, because soon referring to an super fund trustee borrowing
as an ‘instalment warrant’ borrowing will be like to referring to a train ticket as costing 3 pounds
and 2 shillings!
3.2 Definition of single acquirable asset
Arguably the biggest change is the clarification of what asset(s) can be acquired. Only a ‘single
acquirable asset’ can be acquired. The definition of single acquirable asset is an asset that is not
money, and is not prohibited by the SISA or any other law from being acquired.
A single acquirable asset includes a collection of assets that are identical and have the same
market value. For example, if a super fund trustee wanted to borrow to purchase 1,000 ordinary
BHP shares, this would be allowable under the new legislation. The shares have the same
market value and are identical. If the super fund trustee were to purchase 500 BHP and 500 Rio
Tinto shares, this would not be allowed under a single borrowing transaction. However, the
SMSF trustee could still borrow for these purchases if it entered into two limited recourse
borrowing arrangements.
This raises the question: what about real estate spread over more than one title? This is very
relevant for farms, commercial properties and for apartments that have car parks or accessory
titles. This will be dealt with as a separate issue later in this paper.
3.3 Refinancing
Refinancing is now expressly allowable under the new legislation.
This is very good news. Until the ATO clarified otherwise in May 2010, the prior ATO view had
been that refinancing was not allowed under the old s 67(4A). This had meant that once a super
fund trustee entered into a borrowing arrangement, it was at the mercy of the lender.
3.4 Repairs are allowable, improvements are not
The new legislation allows for borrowed moneys to be used to pay for repairs and maintenance,
but not improvements.
For example, an SMSF trustee that wants to borrow to buy a house but discovers that the house
is infested with termites. Here, the borrowings could also be used to pay to restore the property
to a state in which it is suitable for occupation by tenant.
The new legislation prohibits borrowed moneys to be spent on improvements. So, for example,
consider an SMSF trustee looking to buy a house that has an old, leaky ceiling. The SMSF
trustee might want to ‘overhaul’ the ceiling and replace it with a new ceiling made from better,
more durable materials. This would be considered an improvement and not a repair. As such, a
borrowing made under the new legislation could not be used to pay for the new ceiling.
Whether ongoing repairs can be the subject of a borrowing is a contentious issue. The new
legislation talks about money spent ‘maintaining or repairing’ an asset, however, in the past the
ATO has been of the view that money applied for maintenance of an asset which is the subject of
SMSF borrowing will result in a new drawdown. Whilst the ATO’s view has softened, there is still
some clarification needed. An objective reading of the legislation would suggest that ongoing
repairs could be the subject of the borrowing.
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5. How the ATO would view additional drawdowns associated with ongoing repairs is where the
issue lies. On one hand, the ATO has released guidance on its website (see ‘limited recourse
borrowing arrangements questions and answers’) to suggest that under s 67(4A) an additional
drawdown will not be in contravention of the SISA. Whereas, on the other hand, the ATO has
taken a binding position in SMSFR 2009/2 that all subsequent drawdowns would constitute a
separate borrowing. This is an area which requires clarification by the ATO.
3.5 Guarantees
A lingering question under the old legislation was whether personal guarantees were allowed.
The Commissioner of Taxation expressed this concern in ATO Taxpayer Alert TA 2008/5 that he
had concerns as to:
whether ... a personal guarantee ... may result in recourse being made to the assets of the SMSF
other than the asset acquired (or any replacement) in the event that the guarantee is enforced
against the trustee as the principal debtor, contrary to the intent that the exception in subsection
67(4A) of the SIS Act only applies to limited recourse borrowings ...
The new legislation s 67A clarifies that personal guarantees are allowable provided certain
criteria are met. Guarantees became popular under s 67(4A) borrowing arrangements with the
major banks despite TA 2008/5 seeking to dissuade these.
3.6 Replacement assets
The new legislation clarifies the circumstances in which an asset that is the subject of a borrowing
can be replaced with another asset. Generally, it is only shares in a company or units in a unit
trust that can be replaced. Further, they can only be replaced with shares or units in the same
company or the same unit trust.
One important implication of this change is that super fund trustees can not effectively have
‘margin loan’-style share trading facilities.
4 Current uncertainties
The new borrowing laws contained in s 67A of the SISA have been in effect for approximately 8
months at the time of writing. The new provisions have clarified a number of factors. However,
there are currently some areas of uncertainty surrounding these new laws. Advisers and clients
need to be aware that even though SMSF borrowing transactions are alive and well, if there is
any breach the ATO are likely to apply a strict approach to enforcement. Thus, we all need to be
aware of the risk areas.
These areas of uncertainty are on the ATO agenda. These issues were most recently covered in
the NTLG Superannuation Technical Sub-Group meeting on 7 September 2010 (there were
subsequent meetings in late 2010 on these topics but no further written clarification from the
ATO). This section of the paper considers the ATO’s responses and practical considerations for
SMSF trustees and advisers.
4.1 Multiple loans for real estate spread over multiple titles
The new legislation states that a borrowing must be applied for a ‘single’ asset. The Explanatory
Memorandum that accompanied the new legislation broadly states that ‘a collection of buildings
each under separate strata title’ can not be treated as a single asset. Accordingly, a separate
loan would be required for each title.
This is very relevant for SMSF trustees looking to acquire apartments because many apartments
might be spread over multiple titles (eg, one title for the apartment itself and another title for the
car park). Similarly, many farms are spread over multiple titles.
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6. The ATO state that where assets are for practical purposes inseparable or where they are an
‘incident ancillary asset of a very small value’ the assets may be treated as one asset. However,
they then state that a ‘strata title with an accessory car park and a commercial premises over
more than one title’ do not necessarily fall within this category. The ATO say they would need to
consider the facts of a particular case to make a decision.
The implication is that, unless a trustee has received positive SMSF specific advice from the
ATO, the conservative approach would be to treat each title as a separate asset. Accordingly, a
separate loan would be needed for each asset. This can be tricky because not all banks are
willing to lend on this basis. Accordingly, before signing any purchase contract, SMSF trustees
should check whether the property is spread over multiple titles and — if it is — be sure that they
are comfortable with the implications before proceeding.
4.2 Borrowing to acquire an off the plan (‘OTP’) apartment
The ATO were asked how they view the purchase by a superannuation fund of an OTP
apartment. An OTP apartment is usually purchased under a contract where the purchaser
acquires the right to the apartment in the future (eg, in 12 to 18 months time, the subdivision has
occurred and the apartment is built and on settlement the purchaser obtains a separate title with
a completed apartment).
Under the new law, borrowing for expenses incurred in improving the acquirable asset are not
permitted. It appears the reason for asking this question was to provide some comfort regarding
the purchase of an OTP apartment would not be considered an improvement but the purchase of
a completed apartment for s67A purposes.
The ATO indicated that the answer depends on the arrangement. One of the ATO’s main
concerns here appears to be whether the borrowing was after the apartment was completed and
the land was subdivided. It is also understood that financiers will generally only lend on the
security of OTP apartments after the apartment is substantially completed (generally up to 70-
80% complete).
There is also a concern in a number of capital cities that financiers are enforcing stricter lending
practices for developers due to a concern that property values may reduce in the near future due
to potential oversupply and other factors.
Accordingly, those wanting to undertake OTP purchases via the SMSF borrowing arrangement
should consider obtaining SMSF specific advice before proceeding to ensure their particular OTP
arrangement will satisfy the ATO’s criteria for the new law.
4.3 Trust not a bare trust — separate GST registration may be required
The new law (like the old law) required the asset being acquired with the borrowings to be held on
trust. The law does not specify what type of trust. It has been very popular for the trust to be
structured as a bare trust. One advantage with a bare trust is administrative savings for GST.
The GST administrative saving comes from the fact that bare trusts generally do not need to be
registered for GST, but rather the ABNs etc of their beneficiaries can be used instead. See
GSTR 2008/3.
However, the ATO have expressed the view the trust on which the property is held may not be a
bare trust. This view has wide reaching implications. The most immediate implication is that all
‘bare trusts’ for borrowing arrangements with commercial properties turning over more than
$75,000 must be separately registered for GST.
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7. 4.4 Can the asset remain in the custodian trust after the loan is repaid?
The view that the ‘trust’ is not a bare trust also raises questions as to whether the asset can
remain in trust after the borrowing is repaid. The concern is whether — once the loan is repaid —
the trust creates an in-house asset risk. The ATO have stated that they will discuss this matter
with APRA and Treasury and in the meantime they will not take compliance action if it involves
purely a custodial arrangement through a bare trust.
If the ATO do determine that assets can not remain in trust once the borrowings are repaid, this
may give rise to stamp duty implications for many SMSFs. On its face, any such transfer gives
rise to a duty liability because it is a transfer of dutiable property. Many jurisdictions have
exemptions provided that a number of hurdles can be met. Such hurdles typically include that the
SMSF trustee can demonstrate that it provided all of the purchase monies and was the real
purchaser etc.
However, many SMSF trustees might lack documentation to evidence this to the satisfaction of
the relevant state revenue office. This is especially the case where the deposit was paid by a
related entity and journalised as a contribution. Other implications could also arise such as CGT
and GST.
Further, if the holding trust is not a bare truste, other tax issues may arise, for example — CGT
and income tax implications. However, the Government is working on a legislative ‘look through’
fix for these issues.
5 Recent ATO IDs on SMSF borrowing
In late 2010, the ATO released six ATO IDs on super fund borrowing. This paper will explore the
ATO’s position taken in three of these interpretive decisions.
5.1 ATO ID 2010/169 — Limited recourse borrowing arrangement – refinancing
In this interpretive decision the ATO has held that refinancing of a limited recourse borrowing
arrangement entered into before 7 July 2010 can be refinanced without contravening s 67(1) of
the SISA (the general prohibition on borrowing).
The money borrowed in the refinancing must be devoted to the specific purpose of discharging
the previous borrowing. Essentially this means that money borrowed from the new lender must be
applied to extinguish or substitute the old borrowing. It follows that any amount of refinancing
which is over and above the discharge of the previous debt may jeopardise the borrowing
exceptions.
The ATO also highlights that a condition of refinancing being allowable is that the new
arrangement must be compliant with s 67A of the SISA. Therefore, any margin lending facilities or
real estate development that the trustee of the SMSF was undertaking pursuant to the old law
would need to cease upon refinancing as a refinancing generally results in a new borrowing
arrangement with associated documentation, which will be covered by the new s 67A.
5.2 ATO ID 2010/170 — Limited recourse borrowing arrangement – third party guarantee
For related party lenders, there is a risk that where no guarantee is provided, that the rights of the
guarantor against the trustee of the fund may be unlimited. The ATO expressed their views in this
interpretive decision as follows:
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 (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.
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8. Thus, finance documents have to be carefully inspected to ensure they do not extend too far.
Especially guarantees and indemnities.
5.3 ATO ID 2010/172 — Limited recourse borrowing arrangement – joint investors
The primary focus of this interpretive decision is the prohibition on an asset which is held jointly
between trustees of two SMSFs. The ruling is applied to a situation where the two trustees held
the property as tenants in common through a single custodian trust. As such, the trustees only
have 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 and each
trustee were to hold their share of the property on a separate bare trust, arguably this is
allowable. It must be clear that the asset being acquired is the share in the property (as opposed
to the property itself). Further, each SMSF trustee must have the right to acquire their tenants in
common share from their respective holding trust after one or more payments is made.
The practical barriers associated with such a structure may, however, be hard to overcome. It
may be hard to find a bank which would lend on this basis. Related party lending may therefore
be less likely to be at arm’s length. Such arrangement should generally be avoided.
6 Conclusions
Broadly, the SMSF borrowing exception has developed greatly since its inception in September
2007. The updated legislation in ss 67A and 67B of the SISA, with effect from 7 July 2010, have
helped clarify a number of issues with SMSF borrowing. However, a number of grey areas
remain. SMSF trustees and advisers should be familiar with the remaining uncertainties before
entering into borrowing arrangements.
As outlined above, there are ways that these uncertainties can be tackled. However, not all of
these risks can be overcome and some hard decisions may be needed.
The documentation for borrowing arrangements are a key part to making sure the transaction
stacks up to scrutiny. There are suppliers of documentation that are not keeping up to date. We
strongly recommend you therefore seek out a supplier who is keeping on top of these changes.
Moveover, each part of the transaction needs to be carefully managed especially the preparatory
stages before a purchase is made.
******
This document has been prepared for the SPAA 2011 National Convention and is based on the
law in Australia as of today’s date. The law is subject to constant change, and accordingly,
expert advice should be obtained if the above information is not acted upon shortly after today’s
date or if there is any doubt in relation to this document. Unless specifically instructed by you in
writing, and subject to you entering into an ongoing client agreement and payment of our required
yearly fee, there is no obligation whatsoever upon DBA Lawyers to notify you in respect of any
changes to the law, ATO policies, etc and how any such changes might impact upon any advice
previously given. Copyright belongs to DBA Lawyers and prior written consent should be
obtained before releasing it to any person other than our client. DBA Lawyers are not licensed to
provide financial product advice under the Corporations Act 2001 (Cth).
Daniel Butler is a director and Nathan Papson is a lawyer at leading SMSF law firm DBA Lawyers
Pty Ltd (www.dbalawyers.com.au). Daniel and Nathan can be contacted at
dbutler@dbalawyers.com.au and npapson@dbalawyers.com.au respectively. This is seminar
paper is general information only and should not be relied upon without first seeking advice from
an appropriately qualified professional.
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