There have been some recent changes to the borrowing and in-house asset provisions of the Superannuation Industry (Supervision) Act 1993 (“SIS”) which may have an impact on how asset purchases are structured in the superannuation environment. However, caution must be exercised at this time, as the changes must be understood in the context of why they were made.
Historically, superannuation funds have not been able to borrow. Borrowing for a super fund was specifically prohibited under section 67 of SIS.
Prior to August 1999, superannuation funds were able to own units in a related unit trust. This unit trust could borrow, it could acquire assets from members and it could provide the unit trust’s assets as security for borrowings. From 11 August 1999, related unit trusts owned by super funds were then regarded as in-house assets (i.e. investments in a related party which are prohibited up to a maximum of 5% of the market value of assets). Where these trusts existed before 11 August 1999, these investments were excluded from the in-house asset rules, subject to certain transitional provisions. These trusts enabled super funds to use their assets to acquire units in a related unit trust, which could effectively gear an asset purchase. Pre 11 August 1999 unit trusts are still an effective vehicle for borrowing, provided certain conditions are met.
In more recent times, super funds started investing in instalment warrants. Instalment warrants are assets whereby an investor would acquire a beneficial interest in a listed share and only pay part of the purchase cost, with the balance being paid by instalments overtime. I don’t propose to go into detail explaining instalment warrants, but the relevant point to note is that the ATO considered that the instalment payable would “effectively” be a borrowing by the fund and therefore could be a breach of section 67 of SIS. However, they recognised that the use of instalment warrants as an investment strategy by super fund trustees was widespread, so they released a number of press releases and other information advising that they would change the law so that super fund trustees could invest in instalments warrants.
And so this is where we are today…
In Tax Laws Amendment (2007 Measures No.4) Act 2007 (Amendments) the government has amended section 67 and 71 (the in-house asset provisions) of SIS to enable super fund trustees to invest in instalment warrants. However, the amendments to these sections appear to have a much wider application.
Essentially, these amendments extend to transactions, that, if structured correctly under section 67(4A), appear to enable a super fund trustee to invest in a trust and use borrowings to fund the purchase of an asset. I do stress, that for the transaction not to be in breach the provisions of SIS, the transaction must be structured correctly. The essential ingredients of section 67(4A) are:
- The super fund trustee must borrow;
- A trust must exist which owns the asset;
- The super fund trustee must have a beneficial entitlement to the asset;
- The super fund trustee must have an obligation to make further payments for which they will ultimately have a right to become the legal owner;
- The trust must be for one asset only; and
- The rights of any lender are limited to the asset only.
There are many issues to consider in terms of the application of these amendments. The main point I want to raise is that these amendments DO NOT MEAN that “a superannuation fund trustee can now borrow to acquire assets”. Super fund trustees are still prohibited from borrowing, except under section 67(4A). There is an ability for a super fund trustee to borrow, but the way in which the trustee borrows must be structured to comply with section 67(4A) of SIS. The application of the other provisions of SIS must also be considered, including the prohibition on super fund trustees in providing its assets as security. The jury is out at the moment as to whether the trustee of the trust that purchases the asset can provide a charge over the asset. Also, unit trusts and discretionary trusts will not meet the requirements of section 67(4A) as the super fund trustee must have a beneficial entitlement to the asset, which is not the case with unit and discretionary trusts. The trust must be drafted to ensure compliance with section 67(4A).
It’s early days with regard to these amendments, and care needs to be taken if you are considering using these arrangements to acquire assets in your super fund. Some commentators are saying that the application of the amendments to assets other than instalment warrants is clearly not what the government intended, however the amendments are law. I do note that the in-house asset rules have been changed to exclude these trusts from being in-house assets, provided that the asset owned by the trust would ordinarily not be an in-house asset.
I’ll keep you posted as this unfolds further. In the meantime, if you would like to discuss further please don’t hesitate to contact us on 07 3833 3999.