Both the Australian Tax Office (ATO) and the Self Managed Superannuation Funds Professionals’ Association of Australia (SPAA) have gone public in recent times to warn SMSF trustees and their advisors about borrowing. In particular, it has been the limited recourse borrowing arrangement, often relating to property, that has attracted their attention.
Certainly ATO Acting Commissioner Bruce Quigley didn’t mince his words when he said recently that he is concerned that people are using their SMSF to invest in property without fully understanding their obligations under the law or that some people are seeking to take advantage of certain types of arrangements.
“We have observed that some arrangements are deliberately entered into to get around the law, which can result in the fund’s trustees being disqualified, facing civil penalties or even facing criminal charges,” he said.
A dim view on debt
Quigley’s sentiments have been echoed in different forums by Australian Securities and Investments Commission (ASIC). No one should be under any illusions that the ATO and ASIC will take a dim view of trustees and advisors who stray outside the letter of the law when using debt.
As the ATO website states, “while we and ASIC do focus on making sure advisors and promoters do the right thing, you as SMSF trustees are ultimately responsible for entering into and operating correct borrowing arrangements. Severe penalties can apply for getting it wrong, so you must be careful.”
In SPAA’s opinion, their concerns have merit. Indeed, to a large degree, they are shared by SPAA, which recently issued a comprehensive fact sheet – designed to be help SMSF advisors alert and educate their clients – detailing the risks and issues that trustees should consider before embarking on this strategy.
In SPAA’s fact sheet, the risks were clearly documented. They include:
- Only assets that the SMSF trustee is not otherwise prohibited from acquiring can be bought under a limited recourse borrowing arrangement.
- Assets acquired under this arrangement cannot generally be replaced with a different asset. In practical terms this means alterations to a property can’t be made if they fundamentally change the character of the asset.
- The potential for extra costs.
- Loan repayments are deducted from a fund, meaning it must always have sufficient liquidity to meet repayments.
In an accompanying letter, SPAA added that limited recourse borrowing arrangements that did not comply with the law could cause considerable problems for SMSFs and that some trustees may simply be unaware of the serious consequences.
Two sides to gearing
Trustees, and their advisors, should be cognisant of all the risks. But that’s only one side of the story. Used in the right circumstances, a limited recourse borrowing arrangement can assist members to grow their superannuation savings. Therefore trustees should also be aware of the potential benefits. In essence, there are three:
- It allows an SMSF to borrow for investment purposes, enabling a fund to acquire an asset that it may not otherwise be able to afford.
- There are tax concessions. Any investment income received by the SMSF is taxed at the concessional superannuation rates. This can be quite considerable as the income received from the acquired asset will be subject to no more than 15 per cent tax.
- Finally, there is asset protection because, generally, superannuation assets are protected against creditors in the event of bankruptcy. This protection extends to assets that the superannuation fund has acquired a beneficial interest in.
These are solid reasons for some SMSFs to use gearing; but not all. To avoid a lot of heartache later, the message is clear; all SMSF trustees should get professional advice before embarking on a gearing strategy.
Peter Burgess is technical director of the Self Managed Superannuation Funds Professionals’ Association of Australia
