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Self Managed Super Fund (SMSF) Article
Reviewing New Property Product
By Tony Negline.
This article may be out of date.
13th June 2007
In the Republic about 2,500 years ago Plato said that, “necessity is the mother of invention”. He was telling us that a need or problem encourages creative effort.
Examples of human’s ingenuity can be found everywhere especially when it comes to avoiding government tax, penalties or restrictions. During Queen Victoria’s reign the British government taxed windows which were defined to include anything that provided ventilation. As a result the poor lived in houses which were very badly lit and poorly ventilated whilst it became fashionable for the external walls of the wealthier homes to have decorative features that looked like windows. This fad found its way to Australia where there was no window tax.
I was reminded of this when reviewing a new product which seeks to overcome the superannuation laws that generally stop funds from borrowing.
Super funds are not allowed to borrow if the lending arrangement uses super fund assets as security. In effect super funds can borrow if the lending’s terms are non-recourse which means that if the super fund defaulted, satisfaction for that debt cannot be provided by the super fund’s other assets. This type of lending arrangement will rarely work with real estate and as a result super funds had to find another way around this problem.
To date a common strategy for super funds was to enter into a joint venture or arrangement, often via a unit trust, with a related party of the fund such as fund members. The related party would borrow funds but would need to use non-super assets as security. The medium to long-term strategy is for the related party to repay the debt and move its unit trust holdings into the super fund.
Often these structures are not particularly complicated for experienced hands but it takes someone with an ongoing keen eye for detail and sufficient knowledge of the law to ensure that nothing goes wrong with this transaction over the life of the arrangement. In reality it’s fairly common for super funds and their advisers, mostly unintentional, to muck these arrangements up.
A company called Calliva has developed a new product which gives Self Managed Super Funds that want to invest in commercial real estate another solution. The product is called SuperAccess Property Notes.
The process works as follows - The investor finds a suitable property; Calliva then get the property valued. If this process is okay then the super fund purchases some Property Notes which represent at least 30% of the purchase price of the property as well as some administrative costs. The balance of the property’s purchase price is provided by a five year fixed interest loan.
The super fund then leases the property from the owner. The super fund then in turn leases the property to a tenant it has found. The lease payments made by the super fund’s tenant (which must be for a minimum of five years and be based on normal commercial arrangements including provision for indexation) are then used to cover the interest cost on the borrowing and administration costs. If there is any money left over, it is used to reduce the outstanding borrowings.
This whole structure can last for up to 20 years. That is, it can be based on 5 + 5 +5 + 5 year terms. The fixed interest rate on the borrowing is reset to the prevailing rate at the end of each five year period. If the super fund wants to finish this arrangement early then they may do this if they want to pay a break-fee (called an option right fee) of $1,850.
Importantly Calliva has received a tax office Product Ruling on this structure. The Ruling provides certainty about the tax impacts of entering into this transaction unless of course the law is changed. Depending on the size of the transaction they may have to be registered for GST. Some funds may want to voluntarily register for GST.
More importantly the Product Ruling specifically says it does not provide protection for the superannuation laws. In other words the ATO’s Product Ruling does not state that it provide certainty that this structure does not breach the super rules. The law does not allow the ATO to provide this certainty and trustees must get their own advice.
So does this product satisfy the super laws? This will very much depend on the motivation as to why the product is being used. Issues to think about include the sole purpose test (have fund assets solely been used to provide member retirement benefits), providing financial assistance to members or their relatives (has the fund, directly or indirectly given financial assistance, including providing fund assets as security, to people or entities related to the fund) and borrowings prohibited (has the fund accidentally borrowed funds).
It will be important for super fund trustees to get robust advice on whether they satisfy the super laws.
Calliva believe that a range of clients will be interested in this product. These include people who effectively want to use gearing in their super fund. Another potential market is parent’s who need to plan for their retirement whilst helping their children to take-over a business and property without having to take on large debts.
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