1. Scott Hay-Bartlem, Partner, SMSF Specialist Adviser TM 25 May 2018
SMSF borrowing - top ten tips and traps North Queensland Law Association Conference
Scott Hay-Bartlem, Partner, SMSF Specialist Adviser TM May 2018

2. Overview Super borrowing been with us some years
Downside of getting it wrong is quite serious…
Quite technical
Top 10 tips
Including alternatives

3. A summary of the rules… SMSF trustees generally not allowed to borrow
Asset held on trust
SMSF gets title after paying instalments
Lender’s (and others’) right limited to asset
Asset SMSF could have acquired
Section 67A allows trustee of SMSF to borrow

4. 1. Get the structure right
SMSF borrows
Bare trust owns the asset
If not
Borrowing prohibition
In-house asset
Consequences
Admin penalties - $10,000+
Non-compliance – top tax rate on assets

5. 1. Get the structure right
Members guarantees
Bare Trust
Contributes funds
SMSF
Bank
$$$
Sole Beneficiary
Purchases
non-recourse mortgage

6. Single acquirable asset
2. What asset?
The SMSF must be able to acquire
In-house assets
Buying from related parties
Business real property
Listed securities
Some allowable in-house assets
Market value
Usual terms
Single acquirable asset

7. Single acquirable asset SMSFR 2012/1
2. What asset? (cont’d)
Single acquirable asset SMSFR 2012/1
Single legal thing unless identical and identical value
One title
Must sell together legally
‘Unifying physical object’
‘Permanent in nature’
‘Not easily removed’
‘Significant in value relative to the value of the asset’

8. Examples 2. What asset? Strata lot + car park if must go together
Building over two lots
Off the plan + deposit
Option + subsequent purchase
Multiple drawdowns

9. Multiple assets? Fit outs? 2. What asset? 1 bare trust per asset
Separate borrowing and contract for each
Alternative
Bare trust borrows to buy one (or bare trusts)
SMSF buys direct and pays cash for the other
Multiple assets?
Separate asset
Can’t be owned by bare trust
SMSF can’t lease to related party
Tenant can own – lease terms are important
Fit outs?

10. Repair Maintain Improve 3. Can I change the asset?
Occasional and partial
Restores function of asset without changing character
Repair
Prevent defects, damage or deterioration
Includes anticipation of defects
Maintain
Significantly altered
Substantial alterations
Fundamentally different asset
Improve

11. 3. Can I change the asset? (cont’d)
Addition of dishwasher
Fence
Swimming pool
Granny flat
Residential to commercial use
Subdivide
Build on vacant land
Extend existing building

12. 4. Can a related party use the asset?
Yes, but
Written lease
Arm’s length terms
Tenant improvements
Wholly and exclusively used in a business
Sole purpose (Montgomery Wools case)

13. 4. Can a related party be the lender?
Yes!
Seems simple!
Limited recourse
Arm’s length terms
Non-arm’s length income
If loan from a company, Division 7A?
But:

14. 4. Related party lenders (cont’d)
Would the bank have done it and what would the loan look like?
Would the bank have done it and what would the loan look like?
Repayments
Interest rate
Interest-free or discounted interest loans
Security
Guarantees
Must be documented
Evidence!

15. 4. Related party lenders – ATO view
If cannot prove on commercial terms, all income from the arrangement is ‘non-arm’s length income’ (NALI)
Taxed at top marginal tax rate in fund
Even if in pension phase (0% otherwise)
PCG 2016/5 – safe harbour rules
If comply with these, ATO won’t argue non-arm’s length income just because of loan terms
But since 1 July 2015
Do we need bank offer anyway?
Example 1 is PBR
loan amount: 100% of the loan amount was lent, but the lender did not require mortgage insurance or an upfront risk fee to mitigate the risk of this loan. A commercial lender willing to lend 100% of the value of a commercial property would insist on security over the asset acquired.
loan term: this loan was shorter than what is offered by most commercial lenders, suggesting an arm’s length dealing. However, the flexibility to increase the length of the term indicated a non-arm’s length dealing.
payments of principal: there was no agreed repayment schedule. Additionally, the applicant stated that if the private ruling was favourable, they would treat former repayments as principal-only payments (rather than partially for payment of interest). This indicated non-arm’s length dealing.
interest rate: the interest rate of 7% was indicative of arm’s length dealing; however, the reduction of that rate to 0% would suggest a non-arm’s length dealing.
security: records indicated that the borrower failed to register the mortgage until two years after the loan was made. This indicated a non-arm’s length dealing; however, the fact that the mortgage was eventually registered was consistent with an arm’s length dealing.
Example 2 – Based on TR2014/40

16. PCG 2016/5 – safe harbour rules
Real estate
Stock exchange listed shares or units
Interest rate
RBA Indicator Lending Rates for banks providing standard variable housing loans for investors (5.75% for year)
Variable, or fixed for up to the first 5 years
RBA Indicator Lending Rates for banks providing standard variable housing loans for investors plus 2% (7.75% for year)
Variable, or fixed for up to the first 3 years
Term
5 year max, including elapsed term
7 year max, including elapsed term

17. PCG 2016/5 – safe harbour rules
Real estate
Stock exchange listed shares or units
LVR
70% at establishment or refinancing
Market value at 1 July 2015
Where more than 1 loan, the LVR is the total of all loans
50% at establishment or refinancing
Where there is more than 1 loan, the LVR is the total of all loans
Security
Registered mortgage
Registered charge
Personal guarantee
Not required
Repayments
Monthly principal and interest
Loan agreement
Written properly signed loan agreement

18. PCG 2016/5 – safe harbour rules
Loan terms
Interest rate
Principal repayments
LVR
Lender’s rights
Security

19. PCG 2016/5
ATO not take compliance action if on arm’s length terms by 31 January 2017
But must be on arm’s length terms since July 2015
Interest
Repayments
Wind up
Sell asset
Collapse
Example 1 is PBR
loan amount: 100% of the loan amount was lent, but the lender did not require mortgage insurance or an upfront risk fee to mitigate the risk of this loan. A commercial lender willing to lend 100% of the value of a commercial property would insist on security over the asset acquired.
loan term: this loan was shorter than what is offered by most commercial lenders, suggesting an arm’s length dealing. However, the flexibility to increase the length of the term indicated a non-arm’s length dealing.
payments of principal: there was no agreed repayment schedule. Additionally, the applicant stated that if the private ruling was favourable, they would treat former repayments as principal-only payments (rather than partially for payment of interest). This indicated non-arm’s length dealing.
interest rate: the interest rate of 7% was indicative of arm’s length dealing; however, the reduction of that rate to 0% would suggest a non-arm’s length dealing.
security: records indicated that the borrower failed to register the mortgage until two years after the loan was made. This indicated a non-arm’s length dealing; however, the fact that the mortgage was eventually registered was consistent with an arm’s length dealing.
Example 2 – Based on TR2014/40

20. 5. When the loan is paid off…
Transfer the asset to the SMSF
Can leave in bare trust
Must continue to satisfy LRBA rules
Otherwise, transfer to the SMSF
CGT
GST

21. 5. When the loan is paid off… (cont’d)
Duty
Each State is different
Be careful
Or duty on value of asset at time of transfer…
‘Nominee contract’?

22. 6. Update the investment strategy
Section 52 covenant
Formulate and update
Does it deal with
Proposed investment
Borrowing
Increased risk
What happens on death of member
Insurance

23. If member dies with borrowing in place, what does the SMSF do?
7. What if a member dies?
If member dies with borrowing in place, what does the SMSF do?
Breach of loan/guarantee?
Are we required to pay a lump sum?
Can we pay a pension?
Can we transfer part of an asset?
Are there other assets in the SMSF to provide benefit?

24. 7. What if a member dies? (cont’d)
Unallocated insurance
Provides cash for paying out the interest
Does not form part of the benefit
Trust deed must allow (most do not)
Premiums not from accumulation account
Contribution caps as allocate from reserve
Deductibility of premiums?

25. Often absolute prohibition pre-2007
8. SMSF trust deed
Does it allow?
Borrowing power
Often absolute prohibition pre-2007
Refer to repealed s67(4A)?
Bare trust/custodian
Buy particular asset
Power of attorney

26. 9. Can two SMSFs have one bare trust?No
One trust per SMSF
For multiple fund investments, look at alternative

27. 10. Some alternatives Ungeared Unrelated Pre 1999 unit trust
Unit trusts
Installment contract/vendor finance
‘Joint venture’
Joint SMSF

28. Ungeared unit trusts Exempt from in-house asset rules
Strict Requirements (Regs 13.22B & 13.22C)
No debt or charges
No loans, or investments in other entities
Not acquired assets from related party (except business real property)
Not lease assets to related party, except BRP
Not carry on a business
Arm’s length terms for all transaction
If breach, investments become in-house assets

29. If breach, the exemption
Ungeared unit trusts
Very restrictive
Tangible assets only
If breach, the exemption
Ceases to apply to the existing investment in that entity
Can never apply to any further investment in that entity

30. Ungeared unit trusts How can these be useful? Unit Trust Bare Trust
Units = single acquirable asset
Unit Trust = 13.22C unit trust
Unit trust can :
Purchase multiple assets
Improve the property
Can’t use property as security

31. Unrelated unit trusts
In-house asset rules only apply to a ‘related trust’
‘Related trust’ if ‘group’ has:
Fixed entitlement more than 50% of income/ capital
‘Control’ of trustee
Ability to appoint remove the trustee
Unit Trust
SMSF
Unrelated Party

32. ‘Control’ of trustee Unrelated unit trusts
Effective control - directions or wishes of the group
Majority of trustees?
Majority of directors?
Majority of shares in corporate trustee?
Tie breakers – casting vote?

33. Unrelated unit trusts ‘Group’ - s70E(3)
Member + Part 8 associates
Standard employer-sponsor + Part 8 associates
Part 8 Associates (s70A, 70B, 70C)
Relatives
Tax law partnerships, other partners, spouses and children
Other controlled entities
More than 50%
Effective or practical control

34. Unrelated unit trusts Example SMSF 1 & Party 2 are unrelated
Each party has 50% of units in unit trust
Trustee is a company
Two directors - one from each SMSF
No casting vote
Unit Trust
SMSF
Unrelated Party

35. Unrelated unit trusts SIS Act does not apply Units not in-house assets
Borrow and charge its assets
Invest in other entities, including related parties and trusts
Acquire assets from related entities
Acquire multiple assets
Develop/improve

36. Pre-1999 unit trust Rules changed 1999
Some grandfathered old trusts still out there
Often able to buy new assets and borrow
Where clients have them, can be better answer than LRBA
Limitations - SIS Act – I thought it did not apply?
Section 62 – sole purpose test
Section 65 – financial assistance
Section arm’s length terms

37. Summary Are opportunities And traps – need to get it right!
There are other options

38. Scott Hay-Bartlem Partner
SMSF Specialist Adviser, Chartered Tax Adviser, Trust and Estate Practitioner, Specialist Adviser Family Business T: E: