Borrowing by Self-Managed Superannuation Funds (SMSFs)

Posted by - - Tax & Superannuation Law.

Self-Managed Superannuation Funds (SMSFs) are popular vehicles for investing. There are many reasons why people choose to establish and invest in SMSFs. There are also many downsides to using them: your money is tied up until later in life; you don’t really own any of the assets in a SMSF; you are subject to sovereign risk to a greater extent than is the case with other asset classes. And, until September 2007, you did not have the ability to leverage an investment in a SMSF by borrowing.

Borrowing is now allowed if the following conditions are met—

  • the borrowing is used to acquire an asset that is held on trust so that the fund trustee receives a beneficial interest and a right (but not an obligation) to acquire the legal ownership of the asset (or any replacement) through the payment of instalments;
  • the lender’s recourse against the fund trustee in the event of default on the borrowing and related fees, or the exercise of rights (typically a put option) by the fund trustee, is limited to rights relating to the asset at the time of the action (such as taking possession of, or disposing of, the asset); and
  • the asset (or any replacement) must be one which the fund trustee is permitted to acquire and hold directly (the asset may be any asset that a fund is permitted to invest in directly subject to any other investment restrictions that may be applicable such as those on in-house assets and acquisitions from a related party, which will continue to apply).

The overall structure is commonly referred to as an instalment warrant. As a matter of practice, the borrowing can be provided by a member or by an independent third party, such as a bank. Some banks require that the trustee of the SMSF be a company. In all situations the entity holding the asset is a company which holds on trust for the SMSF. Notwithstanding that there are certain conceptual difficulties (which are largely brushed over by most advisers) the instalment warrant structure is becoming commonplace. Nonetheless, you should always ensure that you obtain good advice in order to be sure whether or not the structure is suitable for your long-term investment goals.

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