The introduction of the “instalment warrant” provisions into the superannuation laws has increased the scope for fund trustees to borrow in order to acquire assets. The instalment warrant concept is simple. It is essentially a borrowing arrangement by which a fund acquires a beneficial interest in an asset with a right to obtain legal ownership by making one or more future instalment payments. The relevant legislation is similarly straight-forward
The core requirements to be satisfied include:
1. The asset acquired must be
- appropriate in terms of the fund investment strategy; and
- of a type which the fund could have acquired directly ( such as real property and listed securities);
2. The borrowing must be limited recourse – that is, no fund asset other than the asset acquired may be given as security;
3. The terms of the borrowing reflect an arms-length arrangement; and
4. There is no limitation on who the lender might be (it could be, for example, a fund member).
This flexible borrowing capability would seem to provide the opportunity for trustees to significantly increase the level of assets able to be acquired by a fund – even providing a mechanism to effectively avoid the contribution caps that have applied to concessional and non-concessional contributions since July 1, 2007. With superannuation being a generally attractive tax environment in which to hold income-producing assets, should the instalment warrant strategy be adopted universally? Clearly no.
Fund trustees contemplating the strategy should firstly confirm that the type of asset under contemplation is appropriate for the fund members and then consider the commercial aspects of the proposed acquisition. This would include consideration of particular tax issues relevant to instalment warrant arrangements which may impact the commercial analysis. These include:
1. An instalment warrant would be considered a “capital protected product” for tax purposes and therefore it is likely that a portion of the interest incurred on the borrowing would be non-deductible. Broadly, that part of the interest paid which is considered referable to the capital protection is deemed to be non-deductible as it is on capital account; where the instalment warrant arrangement is implemented on or after 14 May 2008, the non-deductible portion of interest payments will be the amount which exceeds the RBA standard variable housing loan rate. The excess may be able to be added to the cost base of the asset for CGT purposes.
2. Once a fund has gone into pension phase, if the asset subject to the instalment warrant is allocated to the pension, no deduction will be available for the interest incurred as the income generated by the asset is not subject to tax.
3. The maximum tax benefit available in respect of deductible interest incurred by a superannuation fund is 15 per cent. These tax considerations which impact such things as return on investment should be considered by trustees prior to an investment proceeding as should consideration of future member strategies for the withdrawal of benefits, in particular by way of the pension alternative.