Dangers still lurk when borrowing in SMSFs

Advisers should be cautious when recommending borrowing in self-managed superannuation funds (SMSFs) due to a number of legal issues that are unresolved.

Maurice Blackburn Commercial principal Chris Ketsakidis said there are a number of issues that need to be addressed by the Australian Taxation Office (ATO) and Treasury.

“The question is to what extent are the loans prudential,” he said.

“The ATO has a problem with some of the prudential issues and the impression we have is something will happen.”

Ketsakidis said the unresolved issues include the nature of the security trust, guarantees by members or related parties, re-financing arrangements, capitalisation of interest and multiple drawdowns from a single loan facility.

He said there were also issues with what constitutes an ‘original asset’ and a 'replacement asset’.

“There are some banks with their own products that cannot get large legal firms to sign off on these loan structures because of the unanswered questions,” Ketsakidis said.

“It is about risks and the clients who want to use these loans must be aware of what the grey areas are.”

There are questions relating to investors using these loans through a SMSF structure to undertake property development and there are also questions relating to how the ATO views the asset once it has been developed from a piece of land into a building.

“Is the asset an existing one or a new one?” he asked.

“We don’t know.”

Ketsakidis said the ATO also hadn’t explained the nature of the security trust, which is the owner of the asset the SMSF is borrowing against until the loan is repaid in full.

There are also questions over what is an acceptable rate of interest on the loans and Ketsakidis said if the rate is too low, it could be deemed as a contribution.

“If the interest is too high it could be a breach of the sole purpose test,” he said.

Another problem is if the fund took out a fixed interest loan two years ago, the interest payments could now be deemed too high.

“The fund needs to explain the interest rate it is paying to the ATO and have it documented,” Ketsakidis said.

All these issues have been put to the ATO and Treasury by various bodies and individuals, but Ketsakidis said both authorities have declined to comment, raising suspicions that changes are being planned.

A risk for a client with a SMSF loan would be the implementation of major changes.

“If it was a small change, you could tweak the loan,” he said.

“But a major change could result in the loan being unwound with serious financial implications.”

Ketsakidis said advises should proceed with caution when recommending these structures.

“We are happy for a loan to go ahead as long as everybody understands the risks,” he said.