Borrowing within a Self-Managed Superannuation Fund “SMSF” has become increasingly popular. In fact, prior to 2007 borrowing within Superannuation was not allowed but in September 2007 the law was amended to allow SMSF’s to borrow and over the years this law has been further amended.
Why borrow within your SMSF?
Due to the nature of the regulations borrowing within Superannuation is best suited for the purchase of direct property, either commercial or residential. SMSF trustees who also operate a business can use their existing superannuation balances together with borrowing to purchase the premises from which their business is conducted. This is appealing to many small business owners as rent is now paid to their SMSF as the new landlord. The business receives a tax deduction for the market value rent and the SMSF receives the rent as investment income and is either taxed at a concessional rate of 15% or 0% if the fund is in pension phase.
A further temptation is the capital gains tax savings on the future sale of the property. When the property is sold the capital gain realised is taxed at a maximum of 10% within a SMSF during accumulation phase or potentially tax free if sold while in pension phase.
How to ensure legislative requirements of the arrangements are met?
The borrowing arrangement must have the following features:
- Used to purchase a single acquirable asset.
- The asset is held in trust so that the SMSF trustee receives a beneficial interest and a right to acquire the legal ownership of the asset through the repayment of instalments.
- The lenders recourse against the SMSF trustee in the event of default on the borrowing is limited to rights relating to the particular asset itself.
- The asset must be one which the SMSF trustee is permitted to invest in under the Superannuation Industry (Supervision) Act “SIS Act”.
What are the risks?
Borrowing arrangements within Superannuation are subject to greater regulatory control than similar arrangements outside Superannuation. Risks that relate to Superannuation borrowing in particular include compliance and legislative risk, market risk, liquidity risk and credit risk.
There are also specific rules around improvements to the particular asset within the SMSF as well as refinancing the loan. SMSF trustees should also consider the effect of death or incapacity of the members on servicing the loan.
Should further advice be sought?
It is critical that trustees seek expert financial and/or legal advice before embarking on borrowing within their SMSF. It is important to note that personal advice with respect to SMSF’s and in particular limited recourse loans are considered a financial product and therefore only appropriately qualified advisers are eligible to provide advice in relation to their structure.