Superannuation fund trustees now have the capacity to borrow using the “Instalment Warrant” approach contained in amending legislation which has effect from 24 September 2007.
Whilst this assists with the financing of the activities of a superannuation fund, there are strict rules as to the type of asset which can be acquired with the borrowed funds.
An acceptable asset acquisition is of listed securities (at market value) even where the other party to the transaction is “related” eg a member of the fund or an entity controlled by a member of the fund such as a family trust. Part of the attractiveness of shares is not only the potential return which might be generated within the tax-friendly superannuation environment, but also that they represent a reasonably liquid form of fund investment.
Shares paying franked dividends are often considered sound investments by fund trustees; a refundable franking credit at 30 per cent compared to a tax rate of 15 per cent can assist in obtaining an attractive return on funds invested.
If an SMSF trustee is considering how the proceeds of an instalment warrant borrowing might be profitably invested, are there tax issues which might require consideration before such proceeds were invested in, say, BHP Billiton shares?
Put simply, the trustee should consider the attractiveness of such an investment without the benefit of any franking credits which might attach to dividends received.
In order to obtain the benefit of franking credits, a shareholder must be a “qualified person” in respect of the particular shares which means, broadly, that the shares must be held “at risk” for more than 45 days (90 days for preference shares) during the period –
- commencing on the day after acquisition of the shares; and
- ending 45 days after the day the shares become ex-dividend.
The key issue therefore is the meaning of “at risk.” The tax laws approach the issue by identifying situations where shares are considered not to be held at risk; they include where shares have been acquired by way of a limited recourse loan facility.
There are strict requirements as to the characteristics of an instalment warrant and they include a requirement that the borrowing be of a limited recourse nature i.e. the rights of the lender in a default situation are limited to the asset acquired with the borrowed funds.
In these circumstances the requirement that shares be held at risk for more than 45 days cannot be satisfied where funds used by the SMSF to acquire the shares are by way of an instalment warrant and therefore it would not be possible to take advantage of franking credits received by the SMSF as a shareholder.
Whilst an acceptable return on investment might be obtained without the benefit of franking credits, SMSF trustees contemplating such investments should be careful to ensure that the “at risk” rule has been properly considered before proceeding with their investment analysis.