Borrowing from the Bank / or Yourself

Introduction

Since 24 September 2007 SMSF’s have been allowed to borrow provided certain conditions are met. The SMSF can borrow from a bank, aor any other lending institution, infact can even borrow from your self.

On 7 July 2010 the rules changed so there will be borrowing arrangements in the market place that depending on when the loan was entered into will depend on which rules apply.

What Can I purchase with a borrowed funds?

A SMSF can borrow to purchase any investment or asset that it is allowed to purchase, click here to see examples.  The Asset purchased must be a single asset (or identical eg 100 BHP shares) and cannot be replaced (except under limited circumstances). Replaced means it cannot be improved or altered in any way, except for repairs..

How can I implement a borrowing

In order to implement a borrowing the following are some brief steps to achieve this:

• Do your analysis – to ensure the SMSF is appropriate for your circumstances and analysis that a borrowing is appropriate and achievable for your circumstances. Both analysis should include the sole purpose test and consider the investment strategy.
• Setup a SMSF – obviously miss this step if you already have one but ensure you check the trust deed to make sure it allows you to borrow.
• Arms length basis – ensure all arrangements are be made on a an arms length basis, especially important when the lender is related to the member.
• Setup a new company – “Pty Ltd” to act as trustee, to avoid any legacy issues, contact your Accountant/ Adviser to do this for you.
• Execute the contract to purchase – you should seek advice on the drafting of your contract and advisers may offer differ in there advice on which step comes first. Ensure the asset contracted to purchase is a ‘single acquirable asset‘ and is an asset that is permitted to be acquired by a SMSF, click here for examples.
• Setup a bare trust – before or immediately after execution of contract. The Bare Trust will state the new Company as the Trustee. You can arrange for your Accountant / Adviser to do this, or sometimes its more cost effective to let the bank’s lawyers prepare it depending on the fees the banks lawyers charge to review it.
• Provide the lender (the bank/yourself) documents – to draw up the loan documentation. Where the lender is a related party, be aware of any Div 7 A or UPE issues.
• Execute a limited recourse loan – limited recourse means that in the event of default of the loan conditions, the lender only has recourse against the property in the SMSF, and no other assets of the SMSF. Lenders now often seek guarantees from members in their individual capacities. Ensure you read the loan to make sure it is limited in recourse to the acquirable asset ONLY and if any other securities are obtained by the bank such as a guarantee by members that this guarantee does not extend to assets other than the property of the SMSF. A limited recourse loan can be refinanced by another lender at a later stage if required.
• The SMSF pay the loan repayments – and observe loan conditions.
• The SMSF must not change the single acquirable asset – in respect to the borrowing, The ATO draft ruling <SMSFR2011/D1> explains situations where an asset is considered to have been replaced.
• Termination of Loan – the asset continues to be held on ‘trust’ by the new company until the loan is paid in full. After the loan has been paid in full the property can be vested to the SMSF and the bare Trust wound up. The corporate trustee can be either wound up or used by the directors for some alternate purpose if suitable.

See how a property development may be undertaken whereby the land is changed in circumstances where a <Related Non Geared Unit trust> is created and the units are used as security.  See what the ATO has to say about limited recourse borrowing arrangements – <ATO-Link><SMSF2012/1>.