Greater Certainty for SMSF Borrowing Arrangements

By Bryce Figot, Senior Associate, and Daniel Butler, Director, DBA Lawyers

Introduction

The government has just announced legislation that will be prepared to amend the income tax treatment of ‘instalment warrant’-type loans of super funds. This provides welcome certainty to super fund trustees who have borrowed under these loans, especially in respect of capital gains tax (‘CGT’) concerns.

Background: why concerns arose

There is a general prohibition on super fund trustees borrowing. On 24 September 2007 an ‘instalment warrant’ exception was introduced to the prohibition. This exception is contained in s 67(4A) of the Superannuation Industry (Supervision) Act 1993 (Cth). Paragraph (b) of that provision required that the asset that the super fund trustee acquires with the borrowed moneys be ‘held on trust’. Because the asset is held on this instalment warrant trust for the super fund trustee, this gave rise to a number of questions:

Question 1: If an asset is acquired and then later transferred from the instalment warrant trustee to the super fund trustee, is this a CGT event?

Question 2: If the asset generates income while being held by the instalment warrant trustee for the super fund trustee, who declares the income?  Should it be the legal owner (ie, the instalment warrant trustee) or should it be the super fund trustee?

Question 3: If, once the loan is paid-off, the asset is transferred from the instalment warrant trustee to the super fund trustee, will this constitute a taxable supply and thus give rise to a GST liability of 10% of the value of the supply?

Question 4: If, once the loan is paid off, the asset is transferred from the instalment warrant trustee to the super fund trustee, will this give rise to a stamp duty liability?  This is particularly concerning if the asset is real estate.

The government’s announcement

Specifically in the context of an ‘instalment warrant’ borrowing by the trustee of a super fund the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP, announced that the changes will ensure ‘that trustees of superannuation funds who have entered into permitted limited recourse borrowing arrangements will not face CGT obligations at the time the last instalments are paid’.

This provides a very welcome answer to question 1, namely being that the transfer from the instalment warrant trustee to the super fund trustee will not trigger a CGT event. There had been different views on whether a beneficiary became absolutely entitled on repayment of the loan, therefore resulting in CGT event E5 event at that time.

Further, the announcement states that super fund trustees ‘will be assessed on any income earned on the underlying asset, such as rental income.’  Further, super fund trustees ‘will be able to claim any relevant deductions, such as capital allowance for the decline in value of property.’  Therefore, the answer to question is that it should be the super fund trustee declaring the income.  This also is a welcome answer because it means only a tax return will need to be lodged for the super fund and not for the instalment warrant trust as well. Moreover, this clarifies that the custodian or bare trustee does not require an ABN or a TFN.

The law is proposed to apply retrospectively from 1 July 2007.  This backdated commencement day dovetails in nicely with the ‘instalment warrant’ exception, which was introduced several months afterwards, on 24 September 2007.  Accordingly, all super funds should be covered.

The full text of the proposal is available at  http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1724

A word of caution

Although the above changes have been announced, the actual legislation has not been released yet.  Interested parties are invited to lodge written submissions on the design of this proposal.  Accordingly, the proposal might be altered and without seeing the exact legislation, it is impossible to say for sure that the changes will operate exactly as announced.

GST and stamp duty

Strictly speaking a transfer from the instalment warrant trustee to the super fund trustee could give rise to a GST liability.  However, shortly after the introduction of the instalment warrant exception, the Commissioner of Taxation finalised a ruling confirming that if the instalment warrant trustee was structured and maintained as a bare trust, no GST liability would arise.  See Goods and Services Tax Ruling GSTR 2008/3.  Therefore, the answer to question 3 is that, provided the instalment warrant trust is a bare trust, no GST liability will arise. In any event the proposed changes clarifying the tax aspects will also hopefully clarify the GST position to overcome the need to rely on a GST ruling.

This leaves the question of stamp duty.  Unlike income tax (including CGT) and GST, which are federal taxes, stamp duty is administered by state and territory laws.  This means the position in each jurisdiction is slightly different.  Although each jurisdiction imposes stamp duty on transfers of certain property (eg, real estate), each jurisdiction also has exemptions that might apply.  Many jurisdictions contain an ‘apparent purchaser’ exemption.  This exemption provides that if it can be shown that:

• the super fund trustee was the real purchaser;
• the instalment warrant trustee was a mere apparent purchaser; and
• the super fund trustee provides all the purchaser moneys, including the initial deposit;

• either a nil or nominal duty liability arises.  See s 34 of the Duties Act 2000 (Vic)’.s 55 of the Duties Act 1997 (NSW), s 117 of the Duties Act 2008 (WA), s 39 of the Duties Act 2001 (Tas) and s 56 of the Duties Act 1999 (ACT).  The Victorian SRO has made non-binding comments on their website suggesting that such exemptions would indeed be available.  Many practitioners believe that using a bare trust structure for the instalment warrant trust is very consistent with the ‘apparent purchaser’ exemption. 

Therefore, the bare trust structure is often considered the preferred structure for GST and stamp duty efficiency. Note the recent announcement does not clarify the differences in the state and territory legislation relating to stamp duty and land tax. It would be greatly appreciated if each State and Territory could adopt a consistent approach.

Financial product advice

The Government has also announced that it will require advisers to hold an Australian Financial Services Licence (‘AFSL’) when changes to the Corporations Act 2001 (Cth) (‘CA’) and regulations are made.  Advisers will be given three months from when these changes are made to transition to this new requirement.

Advisers who do not hold an AFSL should therefore consider whether they will need to adjust certain aspects of what they are currently doing in the future in view of this proposal or engage someone with an AFSL.  Some banks already insist on an independent financial advisers issuing a written statement of advice and an independent legal opinion before a client proceeds with a SMSF borrowing arrangement.

When the regulations are passed, there is likely to be a requirement for a specific product disclosure document to be issued with each SMSF borrowing package.

Conclusion

Although ‘instalment warrant’ SMSF borrowing arrangements are still relatively new creatures, there is now greater certainty regarding their use.  Accordingly, the authors expect their growing popularity of their use, especially since the Federal tax issues should soon be clarified.

Nevertheless, the documentation will still be crucial and will have an impact on the tax consequences, especially the stamp duty implications. 

Bryce Figot is a senior associate and Daniel Butler is a director at leading SMSF law firm DBA Lawyers Pty Ltd (www.dbalawyers.com.au). Bryce and Daniel can be contacted at bfigot@dbalawyers.com.au and dbutler@dbalawyers.com.au respectively. This is article is general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.