The superannuation borrowing rules

The steps involved in undertaking a borrowing arrangement to purchase a property.

The superannuation borrowing rules in Australia: Superannuation funds are generally prohibited from borrowing money. 

 However, there are a small number of   exemptions that apply, including an exemption for limited recourse borrowing arrangements (LRBAs). 

The rules that enable superannuation funds to borrow to invest are contained in section 67 of the Superannuation Industry (Supervision) Act1993 (SIS Act). 

 The rules can be complex and significant penalties apply if the rules are not followed precisely.

There are four conditions that must be met for limited recourse borrowing arrangements:

·   The borrowing must be applied to the acquisition of a single acquirable asset.

   The acquirable asset must be held intrustso tha tthe superannuation fund obtains a beneficial interest in the asset

·   The superannuation fund has the right (but not the obligation) to acquire legal ownership of the asset.

·   The rights of the lender, or any other person, against the superannuation fund trustee in connection,

with default are limited to the asset (limited recourse loan)

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Singular nature of an asset

Borrowings can only be used to acquire a ‘single acquirable asset’ or a ‘collection of identical assets’.   

However, determining that a particular property is a single asset can be more difficult than it may first appear.

In many instances a property maybe held under several legal titles.

Often these are for historic reasons such as easements created across a property or the joining of several titles.

A commercial building may have been built over two titles of land but in practice the land and building,

are utilised as one asset. 

Another common example is residential apartment that has a car park included in the sale of the property.

Where they are on separate titles they could potentially be sold separately at a latter date and,

therefore fail the requirements.

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Held in trust

The asset needs to be held in holding trust, a trust that only holds the asset, for the duration of the loan.  

There are many names for these types of trusts but they are all bare trusts, they don’t perform any function or transactions other than holding the asset.   

Most lenders will require the trustee of the holding trust to be a corporate trustee.

 The trustee cannot be the same company as the SMSF trustee company however it may have the same

directors as the SMSF corporate trustee (ie the members).

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Ownership right

The SMSF must have the right to acquire ownership of the property.

This requirement means that the SMSF cannot purchase a property jointly with any other party.

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Limited recourse

The requirement regarding the limited recourse nature of the loan means that only the asset purchased can be used,

as security for the loan.

The limited recourse nature of the loan provides an additional layer of risk for the lender which is likely to be reflected,

in a higher interest rate.

It is extremely important to ensure that the loan arrangement complies with this provision of the legislation.  

And just because the front page of a loan document is titled ’Limited Recourse Loan’ doesn’t necessarily mean that,

it is in-fact a limited recourse loan.

Guarantees

Personal guarantees can be provided however they are limited to rights relating to the acquirable asset,

the value of the acquirable asset is the maximum amount available from the fund upon default of the loan from the lender.

Any rights of a guarantor (or any other person) against the trustee of the fund are strictly limited,

to the acquirable asset.

These measures ensure that no claim against the superannuation fund trustee could result in a claim on other assets of the fund.

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Understanding the basic structure

There are generally five parties involved in the limited recourse borrowing arrangement:

·   The SMSF trustee

Most lenders require the SMSF trustee to be a corporate trustee.

·  The lender

·   The holding trust trustee

·   The vendor

·   The member

lender lends money to the SMSF

The diagram outlines the following process:

1.     The lender lends money to the SMSF.

2.     The SMSF uses the loan money plus a portion of the SMSF balance to purchase a property.

3.     The vendor transfers legal ownership of the property to the holding trust trustee.

The beneficial owner of the property will be the SMSF

4.     The SMSF charges its beneficial interest in the property to the lender.

5.      Tenants pay rental income to the SMSF.

6.     Members make contributions to the SMSF.

7.     The SMSF makes loan repayments to the lender.

At the end of the loan term, the SMSF has the option to either sell the property and repay any remaining debt or repay the remaining debt and take direct ownership of the property.

Replacement assets

The legislation clearly prescribes the circumstances in which an asset can be replaced.   

Generally, where an asset that is subject to a borrowing is sold, the loan will need to be repaid. 

A new loan arrangement will need to be established for any future borrowings. 

For example, a client purchased an apartment in their SMSF using a borrowing arrangement.  

The client is then presented with the opportunity to purchase a better apartment and therefore wishes to replace their existing apartment with the better apartment.

 In this instance, the client will need to sell the original apartment and extinguish the loan. 

A new borrowing can then be undertaken to purchase a new apartment.

Section 67B of the SIS Act specifies instances when an asset cannot be replaced and these include:

·   as a result of an insurance claim proceeds for loss of original asset.

·   replacement of title upon subdivision or rezoning.

·   replacement by way of property improvement.

Importantly, any changes that are made to the original asset are likely to classify it as a replacement asset and be in breach of the borrowing provisions. 

 For example, if a block of land is purchased using a borrowing, a dwelling cannot then be built on the land as this will alter the nature of the originally acquired asset – the land.

This applies regardless of whether the dwelling is financed by a borrowing or not. 

The legislation allows for an asset subject to a borrowing to be maintained or repaired, but not improved or altered.

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