Peter Burgess compares limited-recourse borrowing with related unit trusts to see how the options stack up.

With the introduction of the limited recourse borrowing rules, the trustees of self-managed superannuation funds (SMSFs) now have a wider choice of investment options. The ability of an SMSF to acquire an interest in an asset, even though it may not have the necessary capital to purchase the asset, is not a new phenomenon. In limited situations, SMSFs have for many years been able to invest in structures which utilise borrowed funds, either directly or indirectly, to acquire an asset.

In this article we discuss the use of a Division 13.3A unit trust, and briefly outline the main advantages and disadvantages of this approach versus a limited recourse borrowing arrangement.

What is a Division 13.3A unit trust?

A Division 13.3A unit trust is a related unit trust which satisfies the requirements of regulations 13.22C or 13.22B of the Superannuation Industry (Supervision) Regulations 1994 (SIS Regulations). Units acquired by an SMSF on or after June 28, 2000 in a related unit trust which complies with regulation 13.22C are excluded from the definition of an in-house asset in section 71(1) of the Superannuation Industry (Supervision) Act 1993 (SIS Act). This exclusion applies despite the unit trust being a related trust of the fund. The same exclusion applies to units acquired by an SMSF before June 28, 2000 in a unit trust which complies with the requirements of SIS Regulation 13.22B.

Furthermore, the general prohibition on SMSFs acquiring assets from a related party of the fund does not apply if the asset being acquired is a unit in a trust which complies with Division 13.3A. Therefore, as long as the related unit trust continuously satisfies the requirements of Division 13.3A, an SMSF can jointly invest in that trust with a member or another related party. Over time the units owned by the related entity can be acquired by the fund without contravening the in-house asset rules or the general prohibition on acquiring related party assets.

These arrangements can be useful in situations where funds may wish to purchase real property, but do not have sufficient capital to purchase the property themselves. Using a unit trust in these circumstances enables the property to be purchased by pooling the capital provided by other unit-holders with the capital provided by the fund.

‘The benefits of gearing are often reduced under a Division 13.3A unit trust’

Although Division 13.3A does not allow the related trust to borrow, the provisions of Division 13.3A do not preclude an investor in the trust using borrowed funds to acquire his or her units. Thus it is common under these arrangements for members to finance the purchase of their units in the related unit trust by using borrowed funds secured against one or more of their personal assets.

Superannuation contributions received by the fund enable the fund to acquire the units owned by members and other related parties over time. In turn, this enables such entities to retire any debt which may have been put in place when the units where originally purchased.

What conditions need to be satisfied?

In addition to the requirement that the related unit trust must not have outstanding borrowings, there are also a number of other conditions in Division 13.3A which the related unit trust must satisfy. For example, the assets of the unit trust must not include:

– an interest in another entity or an asset which has been acquired from or is being leased to a related party of the fund (unless the asset concerned is business real property); or

– an asset which is subject to a charge.

The unit trust must also not conduct a business or lend money to another entity unless the loan is a deposit with an authorised deposit-taking institution.