| Investing with
borrowed funds With the
introduction of the limited recourse borrowing rules, the trustees of
self-managed superannuation funds (SMSFs) now have a wider choice of
investment options. The ability of an SMSF to acquire an interest in an
asset, even though it may not have the necessary capital to purchase the
asset, is not a new phenomenon. In limited situations, SMSFs have for many
years been able to invest in structures which utilise borrowed funds, either
directly or indirectly, to acquire an asset. In this article we discuss the
use of a Division 13.3A unit trust, and briefly outline the main advantages
and disadvantages of this approach versus a limited recourse borrowing
arrangement. WHAT IS A DIVISION 13.3A UNIT TRUST? A Division 13.3A unit trust is a related unit trust which satisfies the
requirements of regulations 13.22C or 13.22B of the Superannuation Industry
(Supervision) Regulations 1994 (SIS Regulations). Units acquired by an SMSF
on or after June 28, 2000 in a related unit trust which complies with
regulation 13.22C are excluded from the definition of an in-house asset in
section 71(1) of the Superannuation Industry (Supervision) Act 1993 (SIS
Act). This exclusion applies despite the unit trust being a related trust of
the fund. The same exclusion applies to units acquired by an SMSF before
June 28, 2000 in a unit trust which complies with the requirements of SIS
Regulation 13.22B. Furthermore, the general prohibition on SMSFs acquiring assets from a
related party of the fund does not apply if the asset being acquired is a
unit in a trust which complies with Division 13.3A. Therefore, as long as
the related unit trust continuously satisfies the requirements
of Division 13.3A, an SMSF can jointly invest in that trust with a member
or another related party. Over time the units owned by the related entity
can be acquired by the fund without contravening the in-house asset rules or
the general prohibition on acquiring related part assets. These arrangements can be useful in situations where funds may wish to
purchase real property, but do not have sufficient capital to purchase the
property themselves. Using a unit trust in these circumstances enables the
property to be purchased by pooling the capital provided by other
unit-holders with the capital provided by the fund. Although Division 13.3A does not allow the related trust to borrow, the
provisions of Division 13.3A do not preclude an investor in the trust using
borrowed funds to acquire his or her units. Thus it is common under these
arrangements for members to finance the purchase of their units in the
related unit trust by using borrowed funds secured against one or more of
their personal assets. Superannuation contributions received by the fund enable the fund to acquire
the units owned by members and other related parties over time. In turn,
this enables such entities to retire any debt which may have been put in
place when the units where originally purchased.
WHAT CONDITIONS NEED TO BE SATISFIED? In addition to the requirement that the related unit trust must not have
outstanding borrowings, there are also a number of other conditions in
Division 13.3A which the related unit trust must satisfy. For example, the
assets of the unit trust must not include:
- an interest in another entity or an
asset which has been acquired from or is
being leased
to a related party of the fund (unless the asset concerned is business real
property); or
- an asset which is subject to a charge.
The unit trust must also not conduct a business or lend money to another
entity unless the loan is a deposit with an authorised deposit-taking
institution. If the related unit trust fails to satisfy the requirements of Division 13.3A, the units held by the SMSF in that trust will be classified as an in-house asset. Similarly, if the related trust fails to satisfy the
requirements of Division 13.3A any time after the original units had been
excluded as an in-house asset under Division 13.3A, that related unit
trust will never again satisfy the requirements of Division 13.3A. This
would be the case even after the breach or event, which caused the related
unit trust to fail the requirements of Division 13.3A, had been rectified.
HOW DOES IT COMPARE TO A LIMITED
RECOURSE BORROWING ARRANGEMENT?
If the asset being acquired is real property, a Division 13.3A unit trust is
likely to be a more flexible structure compared to a limited recourse
borrowing arrangement. Unlike a limited recourse borrowing arrangement put
in place on or after July 7, 2010, a property acquired via a Division 13.3A
unit trust is not restricted to a single title property or properties which
otherwise satisfy the definition of a single acquirable asset. Similarly,
unlike properties purchased under a limited recourse borrowing arrangement,
there are no restrictions on improving or replacing the asset acquired via a
Division 13.3A unit trust as long as the trust continues to satisfy the
requirements of Division 13.3A.
There is also no requirement for finance to be provided on a limited
recourse basis. If external finance is required by a related party to
purchase their share of the units in the unit trust, it would normally be
done by using borrowed funds secured against one or more of their personal
assets. Therefore, the cost of external finance would arguably be lower
compared to a limited recourse borrowing arrangement.
However, compared to a limited recourse borrowing arrangement where the fund
typically has sole rights to the property's capital gains and income, the
fund may not have the same rights to income and capital gains under a
Division 13.3A unit trust. Therefore, the investment benefits of gearing are
often reduced under a Division 13.3A unit trust.
A Division 13.3A unit trust is not able to be used if the asset being
acquired is an interest in
another entity - for example, shares in a company or units in a unit trust.
This therefore excludes a Division 13.3A unit trust from being used to
acquire shares or managed funds. The Capital Gains Tax (CGT) implications of
acquiring units over time also need to be considered along with the need to
ensure the unit trust strictly complies with the conditions set out in
Division 13.3A. As mentioned, if the unit trust fails these conditions the
trust will never again be considered a Division 13.3A unit trust and the
trust may need to be unwound, resulting in significant CGT, stamp duty and
other costs. |
CAN A PRE-'99 UNIT TRUST BE CONVERTED TO A
DIVISION 13.3A UNIT TRUST? The effect of sub-regulation 13.22D(1) is that, where regulation 13.22B or
13.22C applies to units held by a superannuation fund and one of the events
listed occurs, those units will no longer be excluded from the in-house
assets of the fund under these regulations. It is the ATO's view that
sub-regulation 13.22D(1) is only concerned with events which happen after
the commencement of the regulations on June 28, 2000 (Minutes of the NTLG
Superannuation Technical Sub-Group meeting held on June 15, 2010). Therefore, provided no event for the
purposes of sub-regulation 13.22D(1)
of the SIS Regulations has occurred since June 28, 2000, and the trust now
complies with the requirements of SIS Regulation 13.22C, the fund is
permitted to purchase new units in that trust without those units being
classified as an in-house asset.
USING BORROWED FUNDS TO ACQUIRE UNITS IN A DIVISION 13.3A UNIT TRUST Section 67A of the SIS Act requires that the borrowed monies are used
to
acquire a single asset which the SMSF is not otherwise prohibited from
acquiring. As an SMSF is permitted to acquire units in a related unit trust
which complies with Division 13.3A, borrowed funds under a limited recourse
borrowing arrangement can be used to acquire units in a Division 13.3A unit
trust. In fact, the underlying property which is owned by the Division 13.3A unit
trust is not restricted or limited by the conditions imposed under section
67A and 67B of the SIS Act. In other words the property owned by the
Division
13.3A unit trust is not limited to a single title asset and can be improved
or replaced as long as the unit trust continues to satisfy the requirements
of Division 13.3A. Using the borrowed funds in
this way can be a n effective strategy as it
combines the flexibility of a Division 13.3A unit trust with the gearing
benefits of a limited recourse borrowing arrangement. However, this
strategy would be limited to the acquisition of real property; and if
external finance is required it would be difficult for commercial lenders
to accept the units in the Division 13.3 A unit trust as security for the
loan. This could potentially be overcome if a related party is able to obtain the
finance themselves and then on-lend the proceeds to the SMSF on a limited
recourse basis. In ATO Interpretative Decision 2010/162, the ATO states
that an SMSF is permitted to borrow funds from a related party of the SMSF
under a limited recourse borrowing arrangement on terms more favourable to
the SMSF. However, what this Interpretative Decision didn't say is that the
transaction must demonstrate the characteristics of a loan and the
documentation must clearly reflect that the trustee of an SMSF has made a
genuine borrowing to acquire an asset.
Peter Burgess is the national technical director of the Self-Managed Super
Fund Professionals' Association of Australia (SPAA)
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