BORROWING BY SELF MANAGED SUPERANNUATION FUNDS (SMSF)

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1 DATE: 4 April 2014 BORROWING BY SELF MANAGED SUPERANNUATION FUNDS (SMSF) Purpose The purpose of this short paper is to briefly explain the opportunity that currently exists for self managed superannuation funds (SMSF) to borrow money to acquire acquirable assets. Aim The aim of this short paper is to explain the legislative and regulatory requirements, highlight the need for careful consideration of the process and assist SMSFs minimise the risks associated with borrowing by SMSFs for the acquisition of assets. Background In about August/September 2007, the then Coalition Federal government enacted legislation that enabled SMSFs to borrow funds for the acquisition of acquirable assets. Since that time, the Superannuation Industry Supervision Act 1993 (Act) has been amended to enable that purpose to be achieved and what I propose to discuss now is the current process that needs to be followed.

2 Review Before the trustees of an SMSF decide to enter into a loan for the acquisition of an acquirable asset, a careful and detailed analysis of the circumstances surrounding the SMSF and a review of the trust deed establishing the SMSF must be undertaken to ascertain whether the trustees of the SMSF do have the power to borrow money and mortgage assets of the SMSF and whether the SMSF can achieve its goal without being in breach of the Act. Powers of the trustee of the SMSF The first step in this process in my opinion is to carry out an investigation of the powers of the trustee of the SMSF to find out whether the trustees have the power within the trust deed to borrow money to acquire an acquirable asset and the power to mortgage or charge that asset in favour of a lender to secure the repayment of the loan facility. This part of the process will involve a discussion with your accountants and a request for them to provide you with their opinion as to whether the SMSF has those powers. If it does not have those powers, it will be incumbent upon the trustees to arrange for a variation of the trust deed to be completed which provides those powers to the trustee. Such a variation is by way of a deed and should be relatively inexpensive and not likely to take an excessive time to complete.

3 Establishment of bare trustee In order to enable the requirements of the Act and the goals of the trustees to be achieved, it is necessary to establish a bare trust which will hold the asset for the trustees of the superannuation fund and grant to the lender a mortgage over the property by way of limited recourse in the event of a default. For the sake of these discussions, when I refer to an asset, I am talking about a land asset and a land asset that is generating income such as a farming business operated from the land. There are limits on the type of asset an SMSF can acquire. However, for the purpose of this discussion, the acquisition of farming land from which a business is being operated is an acquirable asset and therefore a lawful acquisition. The bare trust is created by a document in which you have a trustee of this bare trust which will then be legal owner of the land. The beneficial owner of the land will be the SMSF. The bare trustee, in my opinion, should be a corporate entity not the members of the SMSF. The deed establishing the bare trust sets out very clearly what is required and must comply with the requirements of the Act. In essence, the trustee of the bare trust holds the land for the SMSF and must do as the trustee is directed by the trustees of the SMSF.

4 The moneys required to acquire the land must come from the SMSF and a paper trail to that extent must be established and maintained. Your lawyer can prepare the deed that establishes the bare trust. Contract of sale The contract of sale must be carefully drafted in relation to the identity and description of the buyer. In Western Australia, the identity of the buyer must be along these lines, namely:- A B Pty Ltd as Trustee for the Bare Super Fund for C D and E F as Trustees for the F G Superannuation Fund care of RSM Bird Cameron, 8 St Georges Terrace, Perth, Western Australia, The deposit must be paid by the SMSF. The bare trustee must not pay the deposit out of its own funds. Lender The lender's lawyers will review the contract of sale, the bare trust and the trustee establishing the SMSF to ensure that the legislative and regulatory requirements have been met. Mortgage The mortgage will be provided by the bare trustee to the lender at the direction of the trustees of the SMSF.

5 Default If there is a default, the lender's recourse is limited to the land the subject of the mortgage and no other asset. The SMSF must not provide any other security to the lender. Transfer of land SMSF The land can be transferred to the trustees of the SMSF after the loan has been repaid. At that point, the transfer from the bare trustee to the trustees of the SMSF must be lodged for the assessment of transfer duty and a request made that it be for nominal duty because of the structure of the transaction. This requirement makes it essential that all of the earlier documents associated with the transaction are stamped and retained in safe custody until the pay out of the loan. Otherwise, double duty could be assessed and payable. Statutory declaration It is our recommendation that a statutory declaration be prepared by one of the trustees of the SMSF at the time that the initial transaction is entered into explaining what was done and why. The statutory declaration can be used later to support the transfer of the land from the bare trustee to the trustees of the SMSF once the loan has been repaid.

6 Conclusion It is possible under certain circumstances, and with all necessary care and attention, for an SMSF to borrow funds to acquire an acquirable asset. An acquirable asset has a particular definition in the Act and must not be breached. The process requires the establishment of another entity to hold the acquirable asset and to enable it to be mortgaged in favour of the proposed lender. Once the loan has been repaid, the land can be transferred to the trustees of the SMSF. Example John and Mary Smith are trustees of a SMSF known as the Gungin Superannuation Fund. They are the sole members of the SMSF. They hold in their SMSF approximately $500,000. The 1,000 hectare property adjoining their farm land has recently come upon the market for sale and they wish to acquire it. However, they do not have sufficient funds to do so but would like to acquire it in the name of their SMSF.

7 They approached their accountant who has advised them that their SMSF does have the power to borrow and to secure loans. Their accountant has instructed their lawyers to prepare a bare trust with Gungin Pty Ltd as trustee of the Gungin Bare Trust. The Gungin Superannuation Fund will be the beneficiary of the bare trust. The trustee of the bare trust has now placed an offer to purchase the 1,000 hectares and made application to a bank for a facility of $1.75 million. The bank has indicated that it is willing to advance the funds under certain terms and conditions. The trustees of the superannuation fund have paid a deposit of $500,000 into the trust account of the selling agent. The bank's lawyers are considering the relevant bare trust deed, contract of sale and deed establishing the Gungin Superannuation Fund and have requested that John's and Mary's lawyers and accountant certify that the trust deed establishing the Gungin Superannuation Fund is a complying superannuation fund and, further, that the bare trust deed complies with the requirements of the Act. After some three weeks, the lawyers for the bank sign off on the suitability of the bare trust deed, contract of sale and settlement is effected.

8 At the end of the day, the land is registered in the name of the trustee of the bare trust. If you would like to discuss any aspect of the matter, please contact us CONTACT Kim Valenti Principal (08) This paper provides a summary of the subject matter covered. It does not render any legal advice. You should first obtain professional legal advice prior to taking any action on the basis of any information contained in this Alert. This article is copyright. For permission to reproduce this article please Kim Valenti: kim.valenti@valentilawyers.com.au