Recent Developments in SuperGearing

8 April 2008

The ATO recently released (4 April 2008) two important documents dealing with SuperGearing:  an FAQ, and also a Taxpayer Alert. 

These documents, while clarifying some issues, raised two significant issues – non-commercial loans and third party guarantees.

Issues which the ATO has clarified

Issues which the ATO clarified:

  • the gearing exception is not limited to traditional tradeable instalment warrants (eg instalment warrants issued by financial institutions over listed securities)
  • the gearing exception applies to any borrowing under any instalment warrant type arrangement which is structured and carried out in a way that satisfies all of the requirements of the new law
  • an SMSF is allowed to borrow from either a related party or an unrelated party.  In either case, the borrowing must be on arms’ length terms (where the lender is an unrelated party – such as a major bank – the ATO is likely to presume that the parties are acting on arm’s length terms.  However, where the lender is a related party, the ATO will be keen to investigate that the terms are, in fact, arm’s length).
  • granting a charge (eg a mortgage) over the property acquired by the borrowing will not breach the rule against charging assets
  • the governing rules of the fund must expressly permit the trustee to enter into borrowing arrangements and to grant charges over fund assets
  • if the borrowing is repaid, the transfer of the asset from the security trust to the fund will not be treated as a related party asset acquisition
  • the security trust cannot be a unit trust

Issues which the ATO is still thinking about

The ATO is still thinking about these issues (and has not as yet made up its mind):

  • whether an arrangement which permits re-financing is within the new gearing exception
  • whether an arrangement which permits capitalising of interest is within the new gearing exception
  • whether an arrangement which permits multiple drawdowns is within the new gearing exception

Non-Commercial Loans

Where the lender is a related party to the fund, the interest rate charged on the loan must be a commercial rate of interest.  If the rate is either in excess of or below a commercial rate, the borrowing will not satisfy one of the preconditions for the exception to apply.

A loan rate which is above commercial rates may be viewed by the ATO as a benefit stripping arrangement.  While a loan rate which is below commercial rates may be viewed by the ATO as a de facto “contribution” and, as such, subject to contributions tax and will be counted for the purposes of the contribution caps.

Third party guarantees

The ATO has indicated its concern about the issue of third party guarantees.  Many lenders will insist upon (or provide the loan at a lower rate) if the borrowing super fund is able to provide a guarantor for the loan. 

Often a member (or an entity associated with the member) will consider becoming a third party guarantor.  The issue arises whether by providing the guarantee has the non-recourse element of the borrowing (which is one of the necessary preconditions for the borrowing to be within the new gearing exception) been undermined. 

If there is a default by the fund, the lender will look to the third party guarantor to make good the short-fall.  The third party guarantor will, in turn, look to the fund and, by looking to the fund, expose other assets of the fund as the guarantor’s right of indemnity will be against all the assets of the fund.

So long as appropriate documentation is in place, which modifies the guarantor’s rights, in our view the third party guarantor will not have recourse to the fund. 

Consequently, the ATO’s concern will not arise.

What to do?

If you are thinking about SuperGearing, remember proper legal advice is critical.  The correct legal structure and documentation for the transaction may be the difference between a successful transaction – which achieves your goals – and one which does not, but only provides regulatory and compliance headaches.

Important points to remember about SuperGearing:

  • Proper legal documentation is vital
  • The borrowed money must be used (and only) used to acquire the asset.  The borrowed money must only be released at the time the contract of sale for the asset settles.

For assistance with your SUPERGearing legal requirements, please call Michael Hallinan on (02) 8296 6266.

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