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Self Managed Super Fund (SMSF) Article
Buy through a fund and add significant value

By Tony Negline.

This article may be out of date.

17th June 2009

Click here to buy - A How To Book of SMSF's by Tony Negline

This column concludes a discussion we began two weeks ago on super gearing arrangements.

Many investors will be encouraged to enter into super gearing because it allows them to purchase property with their super assets.  We discuss these transactions with a view to holding property.  Many of the points raised could equally apply to other types of assets.

The basic structure of the arrangement is as follows:

When the asset is transferred to the super fund care must be taken because ad valorem stamp duty might be payable if the transfer is not done correctly.  There is little consistency on what State revenue offices want as evidence so that they don't impose stamp duty.  For example NSW demands third party evidence, such as bank statements, that the asset has been held on trust for the super fund.  Queensland simply requires a statutory declaration that the asset has been held on trust.

Is it possible for the super fund's trustee to buy and sell assets in the same bare trust?  There are many reasons why this might occur.  The super fund's trustee might decide to sell the asset held by a bare trustee but is happy to keep the super gearing arrangement in place.  There is some conjecture on this point.  Principal of Townsends Business & Corporate Lawyers, Peter Townsend, says that in theory it's possible but in practise it is unlikely to occur because most arrangements specify the asset and when the bare trust no longer holds that asset that trust ceases to exist.

As detailed previously most of the banks are now offering super gearing loans.  Vince Scully, Technical Adviser at SMSF Finance Specialists, says that several banks are demanding:

Neither of these points are allowed by the super laws.  This later feature might be overcome by empowering the trustee of the bare trust, via that trust's governing rules, to give a charge over the asset.

Scully also says that some banks are asking super fund trustees to warrant that the loan is compliant with all super laws.  It is difficult not to have sympathy for Scully's view that "this is an outrageous requirement" when one considers that in some cases the banks are demanding provisions which break those super rules.

In some cases property investors may be eligible for the Building Allowance tax concession as well as normal depreciation allowances.  Interestingly one of these concessions will be claimed by the bare trust and the other by the super fund.

What about GST?  If the property held in the bare trust is for commercial purposes and the GST threshold is exceeded ($75,000 per annum) then who should be registered for GST – the bare trust or the super fund?  Most accountants will argue that the correct GST entity is the super fund.

Now it's important to understand how using super gearing might add significant value.  The following example has been provided by Mark Wilkinson, a partner at Deloitte Growth Solutions.

Peter is a higher income earner and has $1,000,000 in the Self Managed Super Fund.  He is considering buying a $2 million property in his super fund by borrowing half of the purchase price at 8% per annum interest.

Peter thinks annual running costs will be $20,000.  The super fund will repay the borrowing using future employer contributions.

Peter thinks that the property will be owned for 5 years and will sell it when he fully retires.

If Peter uses super gearing then after five years Peter will have increase his after-tax wealth by over $720,000.

By way of comparison assume that Peter purchased the property in his own name by borrowing $1.8 million at 6% interest per annum (banks are prepared to offer a bigger loan for lower interest rates for personal borrowings).  Using this scenario he is just under $490,000 better off after 5 years.

That is, Peter is $230,000 better off using super gearing principally because of the capital gains tax concessions available for super fund pensions

The ability to make capital repayments using tax effective contributions is a very important feature of the super borrowing is often missed.  The government's reduced concessional thresholds have limited the opportunity in this area but nevertheless this is still an important feature.

Finally anyone looking at super gearing must make sure their super fund's investment strategy reflects this option.

Disclosure: Tony Negline provides services to SUPERCentral Pty Ltd.  Peter Townsend is its managing director.  Tony Negline may be contacted at www.atcbiz.com.au

 

Super Fund owns house

Peter owns house in personal name

Rental income

$80,000

$80,000

Interest cost

$(80,000)

$(108,000)

Other costs

$(20,000)

$(20,000)

Annual net income

$(20,000)

$(48,000)

Tax benefit

$(3,000)

$(22,320)

Annual after-tax cost

$(17,000)

$(25,680)

 

 

 

After Five Years

 

 

Total after-tax cost

$(85,000)

$(128,400)

Capital gain (assuming 7% growth)

$805,103

$805,103

Capital Gains Tax

$0

$0

Overall increase in after-tax position

$720,103

$489,517

 

Recent Full Federal Court case

In early June the Full Federal Court handed down a decision involving distributions of trust income.  The case (Balmford v Commissioner) examined how a trust can treat distributions including capital.  The Tax Office argued that income of a trust does not include capital distributions but ordinary income.  The Court unanimously decided that a better interpretation of the relevant rules is to assume that when a trust distributes capital it will ordinarily be capital in the beneficiaries' hands.  This is an important finding because if the Tax Office argument had been successful, trust beneficiaries would not have received any Capital Gains Tax concessions on trust distributions which would have had interesting repercussions on many trusts and trust like arrangements such as managed funds.

There is currently no indication if the ATO will seek leave to appeal this Full Federal Court decision to the High Court.

The case in passing had to deal with contributions to foreign super funds which were an old strategy which the Courts rejected many years ago.  Nothing new came out of this part of the case.

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This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.

 
 
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