Changes have recently been made to clarify the superannuation borrowing rules. On 6 July 2010, the Superannuation Industry (Supervision) Amendment Act 2010 received Royal Assent and is now law. The Act inserts new sections 67A and 67B to the Superannuation (Industry) Supervision Act 1993 which clarify some of the uncertainties that surround the exemptions for superannuation borrowing.
The amendments have been introduced to resolve uncertainty that exists in respect of the practical application of the current borrowing provisions and to reduce the risks associated with superannuation borrowings. The evolution of products and systems to facilitate superannuation borrowings has resulted in outcomes which the Government perceives as increasing the prudential risk associated with superannuation fund borrowings.
The five main areas covered in the amendments are clarification regarding:
The new sections have effect from 6 July 2010, and borrowing arrangements made prior to that time will be subject to the rules as they previously applied.
The first issue addressed is to confirm that borrowings can only be utilised to acquire a single asset. The only exception is to borrow over a collection of identical assets with the same market value.
Examples of allowable multiple assets include:
A single asset could also include exchange traded funds but excludes separately managed accounts.
A collection of identical assets must be acquired and disposed of as a collection; which means the assets cannot be sold down over time. In addition, distributions can't be reinvested to purchase additional units for unit trusts or managed funds and dividend reinvestment plans cannot be utilised for direct shares.
Examples of non-permissible asset combinations include:
This clarification reinforces the original intent and application of the rules when they were introduced in 2007.
Where clients have entered into a borrowing arrangement which covers multiple assets, they will be able to continue to hold multiple assets (refer to the grandfathering section below).
The second issue addressed is to clarify that expenses that are intrinsically linked to the purchase of the acquirable asset can be included in the borrowing. Typical expenses include conveyancing fees, stamp duty, brokerage and loan establishment costs.
Borrowings may also be used for maintaining or repairing an acquirable asset, for example replacing a leaky gas stove. In practice, borrowings for maintaining or repairing an asset are likely to only apply to property purchases. Borrowings cannot be used to improve an acquirable asset, which restricts arrangements involving property development. Trustees will need to show caution in this area and auditors will seek to ensure that trustees understand the allowable uses of borrowings.
The third issue addressed is to clarify the circumstances in which an asset purchased under a borrowing may be replaced and these are addressed in the new section 67B. The changes remove any opportunity for a lender to require the trustee to replace an asset which falls below a certain value with an asset of greater value than the outstanding loan.
Generally, where an asset that is subject to a borrowing is sold, the loan will need to be repaid. 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.
Replacement assets are limited to replacement shares in companies or unit trusts as a result of specified circumstances including takeovers, mergers, demergers, restructures, schemes of arrangement or trustee assets.
The new section 67B specifies instances when an asset cannot be replaced and these include:
Cash is not an eligible replacement asset under any circumstances and would therefore preclude a takeover on a shares-plus-cash basis from qualifying as a replacement asset. This also precludes structuring a borrowing in the form of a margin lending facility.
The fourth issue addressed is to clarify that 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 limited to the acquirable asset. These measures will ensure that no claim against the superannuation fund trustee could result in a claim on other assets of the fund.
The fifth issue addressed is to clarify that a trustee can refinance an existing limited recourse borrowing. Specifically allowing refinancing may reduce the risk of default on a borrowing resulting from a temporary inability to make a repayment.
Associated expenses of refinancing (eg loan establishment costs, valuation costs) cannot be covered by refinancing arrangement since they are not costs associated with purchasing the acquirable asset. Accrued interest on a borrowing can continue to be capitalised and carried forward.
Refinancing of a limited recourse borrowing that existed prior to the new laws can only apply to a single acquirable asset. This means that any previous borrowings over a collection of assets cannot be refinanced.
Borrowing arrangements made prior to the date of Royal Assent will be subject to the rules as they previoulsy applied. The refinancing of an existing borrowing will constitute a new arrangement and therefore the new borrowing rules will apply. Renegotiating the terms of a borrowing with an existing lender does not constitute refinancing if the renegotiation is simply a variation of an existing loan contract. However, if a renegotiation with an existing lender results in a new contract, then the new borrowing rules will apply.
The amendments introduce a new definition of 'instalment receipt' which is defined as a product that doesn't ordinarily involve a borrowing; rather it is the purchase of an asset by instalments. The inclusion of the new definition clarifies that a superannuation fund's purchase of an asset by instalment (without using a borrowing) is therefore not relevant to the borrowing exemption.
The main conditions of the borrowing have not fundamentally changed and remain that:
On 10 March 2010, the Government announced that superannuation borrowing arrangements will be considered financial products and will therefore need to be provided by licensed financial services providers (AFSL holders). This will preclude self-managed superannuation funds (SMSFs) from 'self financing' borrowing arrangements.
Regulations would come into effect three months after being made to allow product providers time to adjust to the new arrangements. This measure is consistent with other consumer protection measures including margin lending reform and credit licensing.
On 10 March 2010, the Government also announced that they would amend tax law to clarify that CGT is not payable upon the transfer of an asset to a superannuation fund from a bare trust used to undertake a superannuation borrowing. The superannuation trustee who enters into a limited recourse borrowing arrangement to purchase an asset (as permitted by SIS) will be treated as the owner of the asset for income tax purposes.
This measure 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 instalment is paid. The income tax amendments will apply for assessments for the 2007-08 and later income years.
The proposed changes to the borrowing rules clarify the circumstances in which superannuation funds can borrow and confirm that traditional instalment warrants are not subject to the borrowing provisions. This may provide opportunities for advisers to revisit the use of traditional instalment warrants for clients with SMSFs.
The Government has stated that they are keen to ensure that superannuation fund borrowings are not a core focus of superannuation. In addition, a preliminary recommendation of the Cooper Review is that the borrowing arrangements be reviewed in two years' time, following the implementation of the requirement for lenders to hold an AFSL
The area of borrowings in superannuation funds is likely to continue to be an area of interest for both fund auditors and regulators. Clients will need to ensure that they understand the rules and meet the requirements.
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