Understanding ATO's superannuation funds borrowing explanation

New legislation governing how superannuation fund trustees may borrow under a limited recourse borrowing arrangement has left a number of questions unanswered, says Bryce Figot and Daniel Butler.

In July 2010 a new law was introduced to govern how super fund trustees may borrow under a limited recourse borrowing arrangement – see sub section 67A and 67B of the Superannuation Industry (Supervision) Act 1993 (Cth).

However, the new law left a number of questions unanswered.

These questions have been put to the Australian Taxation Office. Responses were received in the NTLG Superannuation Technical Sub-Group meeting on 7 September, 2010.

This article considers those responses and their impact for self-managed super funds (SMSFs).

Multiple loans for real estate spread over multiple titles

The new legislation states that a borrowing must be applied for a ‘single’ asset. The Explanatory Memorandum that accompanied the new legislation broadly stated that ‘a collection of buildings each under separate strata title’ could not be treated as a single asset. Accordingly, a separate loan would be required for each title.

This is very relevant for SMSF trustees looking to acquire apartments because many apartments may be spread over multiple titles (eg, one title for the apartment itself and another title for the car park). Similarly, many farms are spread over multiple titles.

The ATO states that where assets are for practical purposes inseparable or where they are an ‘incident ancillary asset of a very small value’, the assets may be treated as one asset.

However, the ATO then states that a "strata title with an accessory car park and a commercial premises over more than one title" does not necessarily fall within this category.

The ATO says it would need to consider the facts of a particular case to make a decision.

The implication is that, unless a trustee has received positive SMSF specific advice from the ATO, the conservative approach would be to treat each title as a separate asset.

Accordingly, a separate loan would be needed for each asset. This can be tricky because not all banks are willing to lend on this basis.

Accordingly, before signing any purchase contract, SMSF trustees should check whether the property is spread over multiple titles and — if it is — be sure that they are comfortable with the implications before proceeding.

No subdivision of land acquired using borrowings

Many SMSF trustees want to borrow to acquire real estate and then subdivide the land.

However, the new legislation states that assets acquired using borrowings can only be replaced in very specific circumstances.

None of those circumstances apply to real estate. The Explanatory Memorandum considered real estate that is acquired using a borrowing and subdivided.

The Explanatory Memorandum stated that the subdivided land would be a replacement asset and therefore this would not be permitted.

However, Explanatory Memoranda are not law. Further, there are a number of cases where subdivided land has been treated as the same as the original land.

See, for example, Brady King Pty Ltd v Commissioner of Taxation (2008) 168 FCR 558 and Sterling Guardian Pty Ltd v Commissioner of Taxation (2006) 149 FCR 255.

Accordingly, the question was put as to whether a single title to real estate that has been purchased under a borrowing may then be subdivided while the loan is still being repaid.

The ATO adopted the view set out in the Explanatory Memorandum.

Accordingly, for as long as the borrowings are still being repaid, the real estate should not be subdivided.

The implication is that if SMSF trustees want to borrow to acquire land they wish to subdivide, they must first fully pay off the loan before engaging in any subdivision.

Borrowing to acquire an off-the-plan (‘OTP’) apartment

The ATO was asked how it views the purchase by a superannuation fund of an OTP apartment.

An OTP apartment is usually purchased under a contract where the purchaser acquires the right to the apartment in the future (eg, in 12 to 18 months time, the subdivision has occurred and the apartment is built and on settlement the purchaser obtains a separate title with a completed apartment).

Under the new law, borrowing for expenses incurred in improving the acquirable asset is not permitted.

It appears the reason for asking this question is to provide some comfort that the purchase of an OTP apartment would not be considered an improvement but the purchase of a completed apartment for section 67A purposes.

The ATO indicated that the answer depended on the arrangement.

One of the ATO’s main concerns here appears to be whether the borrowing was after the apartment was completed and the land was subdivided.

It is also understood that financiers will generally only lend on the security of OTP apartments after the apartment is substantially completed.

Accordingly, those wanting to undertake OTP purchases via the SMSF borrowing arrangement should consider obtaining SMSF specific advice before proceeding to ensure their particular OTP arrangement will satisfy the ATO’s criteria for the new law.

Trust not a bare trust — separate GST registration might be required

The new law (like the old law) requires the asset being acquired with the borrowings to be held on trust. The law does not specify what type of trust.

It has been very popular for the trust to be structured as a bare trust. One advantage with a bare trust is administrative savings for GST.

The GST administrative saving comes from the fact that sometimes bare trusts do not need to be registered for GST, but rather the ABNs et cetera of their beneficiaries can be used instead. See GSTR 2008/3.

However, the ATO has expressed the view that the trust on which the property is held can never be a bare trust.

This view has wide reaching implications. The most immediate implication is that all ‘bare trusts’ for borrowing arrangements with commercial properties turning over more than $75,000 must be separately registered for GST.

Can an asset remain in a ‘bare trust’ after the loan is repaid?

The view that the ‘trust’ is not a bare trust raises questions as to whether the asset can remain in trust after the borrowing is repaid.

The concern is whether — once the loan is repaid — the trust creates an in-house asset risk.

The ATO has stated that it will discuss this matter with the Australian Prudential Regulation Authority and Treasury and, in the meantime, it will not take compliance action if it involves a purely custodial arrangement through a bare trust.

If the ATO does determine that assets cannot remain in trust once the borrowings are repaid, this may give rise to stamp duty implications for many SMSFs.

On its face, any such transfer gives rise to a duty liability because it is a transfer of dutiable property. Many jurisdictions have exemptions provided that a number of hurdles can be met.

Such hurdles typically include that the SMSF trustee can demonstrate that it provided all of the purchase monies and was the real purchaser, and so on.

However, many SMSF trustees may lack documentation to satisfy the relevant state revenue office. This is especially the case where the deposit is paid by a related entity and journalised as a contribution.

Other implications can also arise, such as CGT and GST.

Conclusion

Although some clarification has been received, a number of grey areas remain. SMSF trustees should be familiar with the remaining uncertainties before entering into borrowing arrangements.

Bryce Figot is a senior associate and Daniel Butler is a director at DBA Lawyers Pty Ltd.