Self Managed Super Fund Borrowing Arrangement
Instalment warrant arrangements and borrowing to invest in your Self Managed Super Fund
 
In September 2007, the law was amended to allow SMSF trustees to borrow money to invest in their super fund. The borrowing arrangements for doing this are known as instalment warrant arrangements.
 
SMSF trustees are now able to enter into an arrangement where they have a right to acquire the legal ownership of an asset purchased with borrowed money, as long as the following conditions are met:
  1. Normal asset restrictions. The asset must be one that the trustee is permitted to acquire and hold according to SISA investment restrictions. For example, it must pass the ‘sole purpose’ test. The limitations regarding related party asset acquisitions must also be satisfied.
  2. ‘Limited recourse’ loan. The only security the lender may have in relation to the loan is over any asset bought with the loan money. This means that the lender’s rights to recover are limited to the asset. For instalment warrant arrangements, some banks may require the SMSF trustees to provide a guarantee as further security. To comply with the ‘limited recourse’ restrictions, the guarantor must disclaim any rights to recover from the SMSF if they have to pay the guarantee.
What is an instalment warrant arrangement?
 
Essentially it is a lending arrangement that permits a SMSF (or any super fund) to acquire an asset through a series of agreed instalment payments. Under such an agreement, the SMSF:
  • makes an initial upfront payment for the asset (say 30% of the purchase price)
  • borrows the balance of the purchase price
  • repays the borrowed money, including interest, in instalments until the asset is paid in full.
While paying off the loan, the SMSF obtains an interest in the asset and is entitled to all income generated by the asset. The lender is entitled to the interest from the loan and is protected by security over the asset which is being acquired by the SMSF.
 
If the SMSF defaults on the loan, the lender is entitled to the asset for which the money was lent, but not to any other of the SMSF’s assets.
 
Instalment warrant arrangements are an effective way for a SMSF to leverage the purchase of an asset. They also allow the SMSF to use its capital to acquire several assets, rather than using all the capital to purchase only one.
 
Click here to see SMSF borrowing diagram
 
What assets can be acquired using an instalment warrant arrangement?
 
Any asset which can be legally acquired by a SMSF can be purchased using an instalment warrant arrangement.
 
The asset must satisfy all requirements under the superannuation law and must also be permitted by the SMSF’s governing rules.
 
Some obvious examples of permissible assets are real property or shares.
 
Who can be a lender?
 
There are no restrictions on who can be a lender. Lenders can be:
  • a financial services organisation (such as a bank)
  • a person or company known to the trustees or
  • a SMSF trustee or member (in their ‘non-trustee’ or ‘non-member’ state).
What are the requirements for SMSFs to borrow through instalment warrant arrangements?
 
Instalment warrant arrangements must comply with the following requirements:
  1. The borrowed money must be used to acquire an asset. The asset must be one that the SMSF is permitted to acquire. This means that the SMSF must still comply with the sole purpose test and the restrictions that apply to in-house assets and to assets acquired from a related party.
  2. The asset must be held on trust – that is in a trust separate from the SMSF. This is so the SMSF does not receive more than beneficiary interest from the asset until the loan is paid. The trustee of this second trust is known as the Custodian. Some lenders require that the Custodian be a company, otherwise the Custodian can be a company or person known to the SMSF trustee. If the SMSF has:a
    • company trustee, then one or all of the directors of the trustee company can be the Custodian, but not the Company trustee itself.
    • Individual trustees, then some (but not all) of the trustees can be the Custodian, but only in their non-trustee capacity.Individual trustees, then some (but not all) of the trustees can be the Custodian, but only in their non-trustee capacity.
  3. The SMSF must have a right to acquire legal ownership of the asset by making one or more payments after acquiring beneficial interest.
  4. The loan must be a limited recourse loan (see information above).
If the lender requires the SMSF trustees to guarantee the loan, and the SMSF defaults on the loan, the trustees may not recover the payment from the SMSF.

If the four conditions are not satisfied, then borrowing money through an instalment warrant arrangement will result in a breach of one or more of the superannuation laws. Such a breach may mean the SMSF is non compliant (which will result in tax consequences) or may result in civil or criminal consequences for the fund’s trustees.
 
What is required for a SMSF trustee to borrow to acquire real property?
 
There are many considerations for trustees when borrowing to acquire real property:
  1. If the SMSF acquires real property from a related party
    • the real property must be commercial property purchased at market rate, and
    • the asset must comply with the in-house asset rules.
  2. Stamp duty must be paid on any real property.
  3. If the lender is a related party of the SMSF, the interest rate must reflect commercial rates.
  4. If the real property is a development site, the purchase price may be funded through an instalment warrant arrangement.
What happens when the asset is sold?
 
When the asset is sold, the proceeds must be used to repay the loan. Any remaining balance can be kept as cash, or used to buy another asset (either outright or using a new loan). The existing loan cannot be used to buy another asset (for example, by redrawing on the loan.)

Can the trustee borrow more to acquire another asset with the proceeds of the sale?
 
The trustees can combine the excess from the sale of the asset with a new loan and purchase another asset. They will require new loan documents and new security documents, but, they can add the asset into the existing Custody Trust – subject to the bank’s requirements and the terms of their Declaration of Custody Trust.

What do SMSF trustees and their advisors need to be wary of?
 
Borrowing to acquire assets is still a new concept. Some areas to be wary of are:
  • the loan must be on commercial terms. This means that if you are in your 50s, a 30 year loan may appear uncommercial to the ATO, even if approved by the bank.
  • 100% of the loan must be used to pay the asset’s price. The loan money cannot be ued to pay any fees, stamp duty, etc.
  • according to the ATO, loans cannot be refinanced in the usual way, as there would be a new borrowing of money, which would not be applied to the purchase of a new asset.
If you require further information regarding borrowing to invest in your SMSF, call us to discuss all of your options, or click here now to arrange for a free consultation.