ATO guides on SMSF Borrowing: guarantees, refinancing, joint investors, favourable terms

The Australian Tax Office (ATO) recently published four interpretive decisions concerning actual taxpayer scenarios which provide guidance on SMSF limited recourse borrowing arrangements. The ATO's key message to SMSF trustees is be aware of the rules and comply strictly. Robert Green

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Interpretive Decisions — SMSF Borrowing

The ATO recently published interpretive decisions — about actual taxpayer scenarios — on the following topics and SMSF limited recourse borrowing:

• related party borrowing on terms favourable to the SMSF;
• borrowing jointly with another investor;
• refinancing an existing SMSF borrowing; and
• third party guarantees of an SMSF borrowing.

Related party borrowing on terms favourable to the SMSF

The ATO has issued guidance about SMSF trustee(s) borrowing from a related party of the SMSF on terms that favour the SMSF — for example, by using an interest rate lower than that which an arm's length lender would offer.[1]

The ATO considers that a loan from a related party is governed by the section of the superannuation law that applies to non-arm's length transactions. The section provides that if the parties are not dealing with each other at arm's length, then:

'the terms and conditions of the transaction [must be] no more favourable to the other party than those which it is reasonable to expect would apply if the trustee ... were dealing with the other party at arm's length in the same circumstances'.[2]

So the ATO:

• believes it is acceptable for the interest rate the SMSF trustee(s) pay to be lower than a commercial rate — though the ATO expects the SMSF's borrowing arrangement to be 'conducted' in a business-like manner; and
• believes that if the terms and conditions favour the lender (for example, by charging a higher than commercial interest rate), then the law would be breached.

Even in light of this guidance, SMSF trustee(s) borrowing from a related party need to be careful if the terms of the borrowing are so favourable to the SMSF that the loan could be seen to be a contribution to the SMSF. For example, the loan might be seen to be a contribution to the SMSF:

• if the rate of interest is so low as to be uncommercial; or
• if the lender forgave the loan without receiving payments.

Joint borrowing involving more than one SMSF

The ATO considered whether two SMSFs that jointly borrowed under a single holding trust (Custody Trust) breached the law.[3] (Although the case was about the old section 67(4A) of the SIS Act that applied before 7 July 2010, the ATO stated that this decision would have been the same under the new 67A of the Act for arrangements entered into on or after 7 July 2010. You can read a summary of the law changes here.)

Facts The relevant background is:

• Two SMSFs jointly borrowed money from a lender;
• The trustee of the Custody Trust mortgaged a property to the lender;
• Each of the SMSFs was an equal beneficiary of the Custody Trust;
• If either SMSF defaulted under the loan, then the agreement was to be terminated; and
• When the loan was repaid, the two SMSF trustees were to jointly acquire legal title to the real property as tenants in common.

Decision The ATO held that the requirement[4] for the asset the SMSF trustee was acquiring to be held on trust and for the SMSF trustee to acquire a beneficial interest in that asset was not met because:

• the asset the trustee of the Custody Trust held was 'sole title to the residential property'[5]; but
• the interest each SMSF trustee acquired was only a partial interest in the property — that is, a joint interest with the other SMSF trustee, each as a tenant in common.

The ATO went on to say that the requirement that the SMSF trustee must have a right to acquire legal ownership of the asset (that is, the sole interest) after making one or more repayments was breached. This is because the loan had to be fully repaid by both investors before the SMSF trustees would each receive their partial interest.[6]

Implications for Cleardocs Customers

The Cleardocs system allows for only one borrower.

Also, given that lenders are unlikely to lend to SMSF trustees on the basis of a partial interest in an asset, joint SMSF borrowing arrangements are unlikely to occur.

Maddocks recommends that SMSF trustee(s) seek independent legal advice if they wish to enter into a joint borrowing arrangement.

Refinancing an existing SMSF borrowing

The ATO has set out its views on refinancing an SMSF borrowing.[7] (Refinancing for SMSF borrowing is allowed — or first dealt with — by the law under the changes that took effect on 7 July 2010. You can read a summary of the law changes here.)

The ATO believes that refinancing an SMSF's limited recourse borrowing arrangement will not breach the Act if:

• the money the SMSF trustee(s) borrow under the refinance arrangement is applied solely to replace an earlier financing arrangement; and
• the earlier financing arrangement meets the requirements of section 67A of the SIS Act (if the refinancing occurred on or after 7 July 2010); and
• the SMSF trustee does not acquire legal ownership of the asset — even temporarily — while changing to the new arrangement.[8] If the asset had been held by the SMSF trustee at any time, then this would have breached regulation 13.14 of the Superannuation Industry (Regulations) 1994 which prohibits charges being placed on existing assets of the SMSF.

According to the ATO's decision, the critical question is whether the new loan has been used to acquire a 'single acquirable asset'.[9] The law says that one of the situations in which a loan can be used to acquire a 'single acquirable asset' is when:

'(ii)' money [is] applied to refinance a borrowing (including any accrued interest on a borrowing) to which this subsection applied (including because of section 67B[10]) in relation to the single acquirable asset (and no other acquirable asset).

The ATO noted that the Commissioner accepts that this has been satisfied if a new loan has been applied 'for the purpose' of acquiring the asset.

This decision concluded that '[a]ll of the money borrowed from the new lender was necessarily expended to bring about that change. On the facts the refinancing served no other purpose'.[11]

Although the decision does not go on to describe what other purposes a refinancing may serve, one alternative purpose may be to access equity in the property.

Third party guarantees of SMSF borrowing

The ATO held that a lender could call on a personal guarantee from a member of the SMSF to recover money lent to the SMSF trustee under a limited recourse borrowing arrangement.[12] (The decision concerned a limited recourse borrowing arrangement established under the old section 67(4A) of the Act that applied until 7 July 2010. You can read a summary of the law changes here.)

The ATO noted that under general law:

• the guarantor has a right to be indemnified by the borrower for any damage the guarantor suffers; and
• that right could extend beyond the asset being acquired under the limited recourse borrowing arrangement.

Under the old law, guarantees provided by the third parties (in this case, an member of the relevant SMSF) do not offend the requirement that the rights of the lender against the SMSF trustee be limited to the asset being acquired. Only guarantees provided by the SMSF trustee would breach that requirement.

The ATO also noted that the new section 67A limits the general law rights of guarantors in that they may now recover only over the asset being purchased through the arrangement.

More Information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Maddocks Superannuation Team.

More Cleardocs information on SMSFs

Order SMSF related document packages

Set up an SMSF

Update an SMSF deed

Set up an SMSF pension

Arrange SMSF borrowing lending docs:

• for when the lender is a bank
• for when the lender is a related party

Set up an SMSF corporate trustee

SMSF Death Benefit Nomination - binding or non binding

SMSF Death Benefit Agreement - binding and permanent

Download

Download a checklist of the information you need to order a document package.

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[1] ATO ID 2010-162.

[2] Section 109(1)(b)(ii) of the Superannuation Industry (Supervision) Act 1993.

[3] ATO ID 2010/172.

[4] Sections 67(4A)(a) and (b).

[5] ATO ID 2010/172.

[6] Section 67(4A)(c).

[7] ATO ID 2010/169.

[8] ATO ID 2010/169.

[9] Section 67A(1)(a).

[10] Section 67B of the Act concerns the situations in which an original asset is replaced by a replacement asset. There are strict rules as to when an original asset can be replaced by a replacement asset.

[11] ATO ID 2010/169.

[12] ATO ID 2010/170.