SMSF borrowing - the latest developments

Although global equity markets have been experiencing a negative trend in recent times, the Australian property market has generally continued to be strong. Because of these conditions, many investors are now finding property acquisitions via their self-managed superannuation funds (SMSFs) to be appealing.

The SMSF borrowing laws in sections 67A and 67B of the Superannuation Industry (Supervision) Act 1993 (SIS Act) were last updated with effect for arrangements entered into on or after 7 July 2011.

There are a number of practical considerations that an SMSF trustee should consider when borrowing with a commercial lender. As these requirements are not set out in the legislation, they are often overlooked and can easily catch SMSF trustees (and advisers) by surprise. This article will outline some of these considerations.

Number of advisers and lawyers

Often when an SMSF trustee considers borrowing to acquire real property, it may not be aware of the professional assistance that is needed in order to complete the transaction.

A typical SMSF borrowing with a bank lender would involve an adviser or accounting 'running point' for the transaction. The SMSF trustee will also need to engage a conveyancing lawyer (as with any property purchase) and an SMSF lawyer to draft superannuation documents specific to the transaction.

The SMSF trustee may also be inadvertently charged by the lender for their lawyers' review of the documentation. 

For those keeping score, there is already up to five stakeholders that the SMSF trustee will need to manage. The situation can be further complicated by other parties such as a mortgage broker and the vendor's parties. 

As such, advisers and SMSF trustees should be aware of the project management aspect of such a transaction.  Ultimately, if all stakeholders are kept happy, the transaction is likely to be relatively smooth. Conversely, poor stakeholder management can cause considerable delays, which may result in additional fees and also penalty interest being payable because of a delay in settlement.

Bank requirements

As mentioned above, banks will typically engage either their in-house legal team, or an external solicitor, to review all relevant superannuation documents for the transaction. The cost for this review is often passed onto the SMSF trustee (borrower).

The bank will typically request documents such as the SMSF trust deed and bare trust deed. As such, it is important that these documents are drafted correctly. It can be challenging to have a document that has a balance between the legislative requirements of the SIS Act and the bank's commercial requirements. The bank will often request additional banking powers to be added, in order for the bank to lend appropriately. 

Not all loans are the same

Similarly with consumers, SMSF trustees have a choice of lenders and loans that are allowable under the SISA.  However, not all loans are the same. As a result, some loans may be more attractive than others. 

Some loans have the additional feature of an offset account, which often results in a higher interest rate on the loan itself. However, we have seen that often an offset account (with a higher interest rate) will still save the SMSF trustee more money in the long run. A financial analysis should be undertaken to ensure that this is the case. 

Unfortunately, redraw is still unavailable for these types of arrangements. The Commissioner's view is outlined in SMSFR 2009/2.

The Commissioner also considers that each drawdown of funds from a loan facility or similar arrangement constitutes a separate borrowing, even if the facility or arrangement makes provision for redraws arising from earlier repayments.

An SMSF trustee should undertake a financial analysis of all the different types of loans available to them to decide which is best.

Refinancing

Under section 67A of the SIS Act, refinancing is also allowable, which means that the SMSF trustee will not be locked into one lender for the life of their loan.

There are some lenders that require the SMSF trustee to adopt the lender's custodian trustee and associated structure.  While refinancing will still be allowable under section 67A, it is questionable whether other tax concessions to do with stamp duty, goods and services tax, and capital gains tax will apply for such an arrangement, given the extensive nature of certain custodian trust documents.

SMSF trustees and advisers should consider the potential tax consequences of re-financing these types of loans before the arrangement is entered into. 

Further, if an SMSF borrowing is commenced before 7 July 2010, the SMSF has more flexibility regarding the arrangement.

For example, the old legislation (section 67(4A) of the SISA) allowed for improvements, as well as had a relaxed definition of what assets could be purchased. The effect of refinancing an arrangement that was previously governed by the old rules, is that the new rules would apply. As such, some of these concessions would be lost as a result. 

Conclusion

There are a number of practical considerations that SMSF trustees and advisers should consider when borrowing with commercial lenders. With the right professional advice, these potential roadblocks can be easily navigated.

The complexities above highlight the need for professional attendances. If an SMSF trustee buys SMSF borrowing documents from an online supplier (or an 'off the shelf' type product), it may not be made aware of the intricacies of the arrangement. Even worse, the SMSF trustee may not be supported if the bank requests changes to the borrowing documents.

As such, advisers and SMSF trustees alike should engage an SMSF lawyer as part of the transaction. The lawyers can draft the borrowing documents, project manage many aspects of the transaction and be on hand to handle any queries from the bank's lawyers. This can result in cost savings and also provide peace of mind for SMSF trustees.

Daniel Butler is a director and Nathan Papson is a lawyer at law firm DBA Lawyers.