In the recently released Financial System Inquiry (FSI) report, the panel recommended that the "Government should restore the general prohibition on direct borrowing by superannuation funds ...", i.e. ban borrowing in super funds.
At present, while direct borrowing by a super fund is allowed, it must be done under very strict borrowing conditions called a 'limited recourse borrowing arrangement' and can used to fund property and share purchases within their superannuation.
What it means for Self managed super funds with an existing borrowing?
The report recommends that funds with existing borrowings should be permitted to maintain those borrowings. Funds disposing of assets purchased via direct borrowing would be required to extinguish the associated debt at the same time. The FSI report refers to this arrangement as grandfathering.
What constitutes an 'existing borrowing'?
There are a number of different possible points in time that might be thought of as important in the commencement of an LRBA, such as:
- when the purchase contract is signed
- when the deposit is paid
- when the bare trust deed is signed
- when any supplementary deed is signed
- when a loan contract with the lender is signed
- when the loan is drawn down
- when the property settles.
While it the legislation on LRBA to date has not been very clear, the arrangement was typically viewed as coming into existence when the when a loan contract with the lender was signed. This time, however, the FSI recommendation clearly used the term ‘existing borrowing’ rather than just ‘existing arrangement’, meaning the critical deadline to qualify for grandfathering will be when the loan contract is made.
What this recommendation means for self managed funds who wants to enter into a LRBA?
Naturally, those who want to engage in LRBAs should do so as soon as possible so that they have an ‘existing borrowing’ as soon as possible in order to maximise their chance of qualifying for grandfathering. However, before rushing into a LRBA, the trustees have to take into account the risks, just as much as the benefits and assess possible measures that can be put in place to mitigate the risks.
It should be noted that a LRBA cannot be put in place over night. Just like any mortgage the LRBA takes time to put in place especially where the lender is a financial institution. So there is a risk for SMSF trustees who have currently signed (or shortly will sign) purchase contracts but have not signed loan contracts with lenders. The danger is that the law might change before the loan contract is signed meaning that they might not be able to borrow to settle the property, because there is no 'existing borrowing' to qualify for grandfathering. This could cause difficulties if the SMSF trustee was relying on borrowing to fund the settlement.
The Financial System Inquiry is not a law making body and its recommendations do not constitute law. At this point it remains a recommendation only till such time more information released by the government. So there is time for super funds to enter into LRBA facility before legislations change to effect the recommendation to ban borrowings in the super fund. Get in before it's too late - contact us now on 02 9299 7044 or at firstname.lastname@example.org.