Changes made to the Superannuation Industry Supervision Act has provided the most exciting opportunity in superannuation in many years. Superannuation funds have been given a "green light" to borrow money for investment purposes.
This article explains the key issues to be aware of when borrowing in super.
Things to Consider
For the first time, the trustees of superannuation funds need to consider the borrowing issues, the risk and return benefits need to be assessed and the investment strategy needs to be updated. Care is needed to ensure that trustees have a long term investment view with a retirement purpose, and that any debt is looked at in this context.
The risks are limited?
The new law says that the rights of the lender against the superannuation fund for default on the borrowing and charges related to the borrowing are limited to rights relating to the original asset.
What the superannuation trustee/members need to have made clear to them is that the whole of the asset is at risk. Especially in the self managed superannuation fund area where single asset investments are not uncommon, is it prudent to put the whole of the fund assets at risk? Would this be the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide? If not then such an approach to these new rules is a breach of section 52(2)(b) of the SIS.
The loan-to-valuation ratios inherently mean that the equity portion of the asset, the part that the superannuation fund has financed with the first installment, is at risk.
Loan-to-valuation ratios, although part of the investment management and documentation process, bring fresh challenges to superannuation.
The new rule is a relaxation of an existing rule, not a new law
New section 67(4A) does not permit a superannuation fund to borrow, it relaxes the prohibition in section 67(1), but only if the conditions within the new exceptions are met.
The proper starting point for an analysis of this new law is not with section 67(4A) but with the prohibition in section 67(1). A superannuation fund must not borrow or maintain an existing borrowing – this rule still applies.
The starting point is to ask the question: is the nature of the arrangement in truth a borrowing. No matter how the arrangement is described, if in truth it is a borrowing then the prohibition in section 67(1) has prima facie application. Once this is resolved, only then do you look to section 67(4A) to determine whether or not the nature of the arrangement is excluded from the prohibition.
To be excluded the money borrowed must have been used to finance an acquisition of an asset. Any other borrowing arrangement fails the new exception to the rule and is in breach of the long standing SIS prohibition in 67(1). So don’t borrow to put money into a trust for a future intention to buy an asset when it is identified, this does not fit the nuances demanded by new section 67(4A).
Section 67(4A) is an exclusion section that saves a superannuation fund from being in breach of the borrowing prohibition. To enjoy the exclusion, the arrangement must comply precisely with the elements expressed in Section 67(4A). There is no room for error. It is not a borrowing; it is a debt funded asset acquisition.
Can the lender be the member or an associate of the member of the superannuation fund?
The answer is they can be, but only if it is a borrowing, not a loan. The superfund should clearly identify the assets which it is its intention to acquire and structure the borrowing accordingly.
Yes, it is exciting to note that new Section 67(4A) does not limit who may be the lender to the superannuation fund. It is the superannuation fund that is borrowing, not the member that is lending.
What about the limits on contributions?
The SIS act defines a contribution in Regulation 1.03 as “contributions”, in relation to a fund, includes:
a) payments of shortfall components to the fund; and
b) payments to the fund from the Superannuation Holding Accounts Special Account ;
But does not include benefits that have been rolled over or transferred to the fund.
The Australian Taxation Office view of a contribution is broad enough to encompass a loan by a member – A superannuation contribution is a payment made to a superannuation fund … to provide benefits for individuals on their retirement or for their dependants on their death.
When is a borrowing a contribution? Firstly ask whether it was a loan and not a borrowing. If it is to boost a member’s superannuation, this may satisfy the sole purpose test but it does not satisfy the 67(4A) requirements. In the words of section 67(4A); the borrowing prohibition does not prohibit a superannuation trustee from borrowing money under an arrangement under which the money is or has been applied for the acquisition of an asset. These are the words around which the arrangement that is a borrowing must be constructed.
How should a trust work?
The new law requires the incorporation of trust. Did you know that a declaration of trust over dutiable property (shares, real estate and units in a unit trust) is liable for stamp duty? There is a real double stamp duty risk in how the trust arrangement is structured if you do not receive good legal advice.
You should also be aware that a document that requires stamp duty and which has not been stamped, at law, is nothing. It will not have achieved its intended effect.
The Investment Strategy of the fund
The strategy must have regard to the whole of the circumstances of the fund, some suggestions of which include:
- The risk involved in an investment;
- The existence or lack of diversification;
- The liquidity of the fund having regard to the demands on its cash resources; and
- The ability of the superannuation fund to discharge its existing and prospective liabilities.
Trustees must make sure all investment decisions are made in accordance with the documented investment strategy of the fund and should seek investment advice or appoint an investment manager in writing if in any doubt.
The Covenants that you as a trustee of a self managed super fund must follow
The trustee of a superannuation fund must:
Exercise, in relation to all matters affecting the entity, the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide.
Ensure that the trustee’s duties and powers are performed and exercised in the best interests of the beneficiaries;
Not to enter into any contract, or do anything else, that would prevent the trustee from, or hinder the trustee in, properly performing or exercising the trustee’s functions and powers;
It should also be noted that under section 52 of the SIS Act a covenant by each of the directors of the trustee to exercise a reasonable degree of care and diligence for the purposes of ensuring that the trustee carries out the first-mentioned covenant, and so operates as if the directors were partiesto the governing rules.