29/09/2011

There is a way that a self managed super fund can take out a limited recourse loan to acquire property and then develop that property, notwithstanding the prohibition in s.67A of the SIS Act. However great care needs to be taken to ensure that the rules are followed very carefully.

The strategy involves the use of a Regulation 13.22C unit trust.

A private unit trust that meets the requirements of Regulation 13.22C (“Regulation 13.22C unit trust”) of the Superannuation Industry (Supervision) Regulations is an important exception to the in-house asset rules.

The investment of a self managed superannuation fund (“SMSF”) in a Regulation 13.22C unit trust owned and operated by the member or a related party will not be treated as an in-house asset of the fund.

Where a SMSF borrows under a limited recourse borrowing arrangement to invest in a Regulation 13.22C unit trust which in turn acquires the underlying asset to be purchased, the trustee of the SMSF will be able to meet the requirements of Section 67A of the SIS Act without compromising the ability of the unit trust to improve, develop or replace the underlying property.  This is not possible if the SMSF borrows to acquire the underlying property directly.

Units in a Regulation 13.22C unit trust meet the “single acquirable asset” requirement of Section 67A if the units acquired by the SMSF are identical and of the same market value.

Security of retirement benefits is an important aspect of the Government’s retirement income policy.  As the assets in a Regulation 13.22C unit trust are not allowed to be charged or placed under lien, the security of the members’ retirement benefits will not be put at risk.

The structural aspect of this strategy is the key to its workability.  It has to comply with both the requirements of section 67A of the SIS Act and Regulation 13.22C of the SIS Regulations, as well as other relevant legislative provisions.  This article deals with the legislative requirements and the important features of this strategy.

Regulation 13.22C of the SIS Regulations

Regulation 13.22C is only applicable to superannuation funds with less than five members.

For a related trust to be eligible for the exception to the in-house assets provisions of the SIS Act the following requirements must apply:

• the unit trust does not borrow
• there is no charge over the assets of the trust
• the trust does not lend money to individuals or other entities except in bank deposits
• the trust does not conduct a business
• the trust does not directly or indirectly lease assets to related parties other than business real property
• the trust conducts all transactions on an arms-length basis
• the trust has not acquired an asset from a related party of the fund after 11 August 1999 apart from   business real property acquired at market value

Section 67A of the SIS Act

Section 67A makes provision for SMSF limited recourse borrowing arrangements, as follows:

• the money borrowed is used to acquire a single acquirable asset
• the asset must  be one that the SMSF would be permitted to purchase and own regardless of whether or not it borrowed to purchase the asset
• the asset must be held on trust by another trustee (the Holding Trustee) so that the SMSF trustee acquires a beneficial interest in the asset
• the SMSF trustee must have the right to acquire the legal ownership of the asset by making one or more payments
• the rights of the lender or any other person for default on the borrowing must be limited to rights against the acquirable asset only (limited recourse) and not against any other SMSF asset

How to Use a 13.22C Trust in a Super Gearing Strategy

The asset to be acquired in this example is real property.  The SMSF trustee wishes to borrow under Section 67A to acquire this property.

1. The Fund enters into a limited recourse borrowing arrangement to acquire units in a 13.22C Unit Trust established by the member and/ or related parties of the member.
2. In accordance with Section 67A, the units in the Unit Trust (single acquirable asset) will be held by a Holding Trustee for the SMSF Trustee which acquires a beneficial interest in the unit trust units.
3. The Unit Trust in turn purchases the real property (or properties) out of the subscription money provided by the SMSF.
4. The Unit Trust can acquire multiple properties out of the trust fund provided by the SMSF as the property or properties acquired are investments of the Unit Trust.
5. Under Regulation 13.22C, the Unit Trust is not permitted to use its assets as security for the SMSF borrowings, therefore the security for the borrowings has to be provided by the member out of its own personal assets and the member has to understand the limited recourse nature of this arrangement.  Generally, lending institutions will not accept unit trust units as security for borrowings. Private lenders may.
6. The structure and the investment are subject to the investment strategy of the SMSF and other relevant rules.
7. As the real property acquired is an investment of the Unit Trust, the Trustee of the Unit Trust is free to carry out property improvement, replacement or development as long as it meets the requirements of Regulation 13.22C.
8. It is possible for the SMSF to own part or all of the units of the unit trust.  Related parties may also be the unit holders.

Traps

A. The units in the Unit Trust must be issued by the trustee of the Unit Trust directly to the SMSF.  The  acquisition of the units by the Fund from a member or related party will be prohibited by section 66 of the SIS Act.  Generally, a regulated superannuation fund is not allowed to intentionally acquire an asset from a related party of the fund, subject to a few exceptions.

B.  While it is possible for the Unit Trust to purchase land and carry out building development on the land, a Regulation 13.22C trust is not allowed to carry on a business.  Therefore, the development activity must be strictly restricted to the investment purpose and the unit trust must not carry on a land development business.

C.  The duty concessions available in some States (NSW – S.62A, WA – S.122, QLD S.119) in relation to business real property acquired from a member and quarantined for the benefit of that member inside the fund, do not apply because the transfer of business real property will be made to a unit trust and not the SMSF.

The strategy in this article is confined to the Regulation 13.22C unit trust which is a related trust.  The restrictions of Regulation 13.22C do not apply to a widely held trust or a trust which is not a related trust which should be considered separately.

If you have any questions in regard to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.