The ATO Comments On Super Fund Borrowing

Since the changes were made to the Superannuation Industry (Supervision) Act 1993 in September, 2007, everyone has been waiting for the Australian Taxation Office to give its view on what is acceptable borrowing by a superannuation fund.

WHAT WERE THE CHANGES MADE TO THE LAW?

Previously super funds were prohibited from borrowing so as not to endanger fund assets in the event of a default.

Under the new rules, the trustee of a superannuation fund can borrow to acquire an asset. The asset subject to the loan it is held in a trust separate from the other assets of the superannuation fund until the loan is repaid and the fund then has the option to acquire the legal interest.

UNDER WHAT CONDITIONS WILL THE ATO APPROVE BORROWING BY A FUND?

The four basic conditions the ATO will recognise are:

1. The borrowed monies are used to acquire an asset, being an asset the fund is not prohibited from acquiring.
2. During the period of the borrowing the asset is held on trust with the fund holding a beneficial interest.
3. The fund has the right to acquire the legal interest by making payments.
4. In the event of a default, the lender is limited to recovering monies by enforcement against the asset alone and has no claim against other fund assets.

WHAT TYPE OF BORROWINGS WILL CONCERN THE ATO?

Loans of concern to the ATO include loans made by a member or related party of the fund at zero or less than commercial rate of interest. Alternatively, if a loan is made by a member or related party at greater than commercial rate of interest, this will also cause concern.

There is no prohibition against the fund borrowing from fund members or related parties who have monies available. Complete loan documentation should be prepared and care should be taken to charge at a commercial rate of interest. This will also require a commitment to ongoing maintenance of the loan agreement to ensure interest rates are adjusted as market rates rise and fall.

Interest capitalisation has also been identified as a concern. The ATO considers this as an indication the money has not been applied for the acquisition of an asset, since the debt is substantially increased by such an arrangement.

PERSONAL GUARANTEES AND SUPER FUND BORROWING

Lenders are likely to require personal guarantees for loans to superannuation funds and members of a fund will agree to benefit the fund.

However, the ATO is concerned such an arrangement may expose other fund assets. Once a guarantor pays a debt on behalf of a defaulting borrower, he/she/it may claim against the borrower for the payment that has been made. This would mean if a claim were made by the guarantor against the trustee of the superannuation fund, that trustee would be indemnified by the fund thereby exposing the other assets.

WHERE TO FROM HERE

The first consideration for any fund wanting to benefit from the new laws is to review its own rules to determine whether it is allowed to enter into any instalment warrant type arrangement. If there is no authority, then no borrowing can be entered into and so amendments to the rules will be required.

Then consider whether borrowing is consistent with the investment strategy formulated for the fund.

A bare trust will then have to be set up to hold the asset to be purchased by the fund. Source the funding and confirm the correct documentation is in place especially if members or related parties are to make the loans.

Finally, identify the asset. Ensure it complies with the legal requirements and does not breach the rules against purchasing from a related party. It must also satisfy the requirements of the lender and, most importantly, be of ultimate benefit to the trust.

Please seek financial and legal advice before entering into these arrangements.