Superannuation Instalment Warrants - new bill changes the borrowing rules and tax implications

As many practitioners are aware, whilst the introduction of section 67(4A) in the Superannuation Industry (Supervision) Act  1993 introduced new investment opportunities for trustees of superannuation funds, there has also been some uncertainty and concern as to the operation of the rules and the permissible boundaries. Treasury has now sought to further clarify the area by the introduction of the Superannuation Industry (Supervision) Bill 2010.

The key aspects of the Bill are as follows:

  • Section 67(A) is being repealed and replaced with sections 67A and 67B that will provide the new borrowing rules.
  • Some of the terms and language used in section 67(4A) is reproduced in section 67A and furthermore, the following structural requirements are being maintained:
    • The existence of a trust with a requirement for separation of legal ownership of the asset and beneficial ownership of the asset;
    • The trustee of the superannuation fund not be able to acquire legal ownership unless it has made at least one instalment payment;
    • The limited recourse nature of the debt (further rules confirm that the lender's rights of recovery are limited to the acquired asset purchased under the arrangement);
    • The prohibition of other assets in the superannuation fund being used as security for the loan to purchase the acquired asset.
  • The additional rules that have been introduced which effectively provide greater clarity and certainty are as follows:
    • The borrowings can be used to assist in the funding of acquisition expenses (eg legal fees, stamp duties) and costs incurred for the purposes of maintaining and repairing the acquired asset, however, borrowed funds cannot be used for the purposes of improving the acquired asset (clearly the concept of a "repair" as opposed to an "improvement" will be an issue that will need to be considered);
    • The trustee of the superannuation fund is specifically allowed to refinance its borrowing against the acquired asset and the refinance can replace capitalised interest of the earlier facility;
    • Subject to a specified exception, each borrowing arrangement can be in respect of one acquired asset only. As such, ordinarily one trust cannot be used to hold two acquired assets (eg two adjacent blocks of land with separate titles). This will affect many existing arrangements that are in place as some advisors have promoted such an arrangement as being possible under the existing laws. The exception to the "one acquired asset one trust rule" is where the assets have the same market value and are identical in nature, for example purchasing 1,000 CBA shares;
    • Whilst there are no specific rules referring to the provision of guarantees by members to the financier as part of the arrangement, this appears to be dealt with in part under the proposed law as it specifically recognises that persons not being the financier may have rights as a result of a default on the borrowing by the trustee of the superannuation fund. The Bill allows such rights provided that the rights of such persons are limited to the acquired asset. Issues such as the interaction between member guarantees and the making of contributions still need to be dealt with in practice (see TRC 7).
    • The replacement asset rules are very narrow and only apply to shares or units that have replaced the prior shares or units as a result of a merger, takeover, demerger or some other form of restructure. A replacement asset will not include assets that are purchased as part of share trading activities.

Where to from here? The clarification of many issues surrounding superannuation borrowing arrangements is welcomed and should assist in providing more comfort and certainty for future arrangements. Some important structural and technical issues do, however, remain and advice should always be obtained before entering into a superannuation borrowing arrangement. We are awaiting a further Bill that seeks to clarify the CGT, income tax and GST issues arising from the entering into of such an arrangement when the acquired asset is transferred from the security trustee to the trustee of the superannuation fund. This may involve the removal of the legal requirement for a security trustee which would assist from a tax and stamp duty perspective. There is no doubting that the importance of getting the right structure for the taxation rules continues to exist.

The new rules will become effective upon the legislation receiving Royal Assent, and may be subject to some changes prior to being passed by Parliament. It will be interesting to see if the ATO apply these new rules as a clarification of the old rules or as a new set of rules applying from a specific date. The issue is obviously relevant for an SMSF’s compliance where there is an existing borrowing arrangement in place (and therefore in determining whether a superannuation fund was in breach of the old rules will be determined by reference to the new rules) or whether there will be some grandfathering and an approach of there having been different rules that applied at different times.

Author: Chris Tsovolos