Tax Structuring Opportunities Unlocked by Recent Law Changes

Our firm has long held the view that the superannuation environment, including self managed superannuation funds (SMSFs), is the most tax effective structure for building long-term wealth. Until recently though, the potential has been limited by strict borrowing prohibitions.

Without the ability to borrow, SMSFs were restricted in the scope of potential investment. Access to investments such as property was restricted in that a SMSF was not allowed to borrow for the purchase. Investors wishing to access the property market were therefore limited to managed fund type products and tend to hold both residential and commercial property outside of the superannuation environment.

The new rules which came into effect on the 24th September 2007 allow a SMSF to borrow funds (subject to strict guidelines) to purchase an asset that would normally be allowed to be held by a SMSF. The existing investment restrictions, including but not limited to, in-house assets, purchases from members and their associates and loans to members still apply.

How this Works

• Borrowing (with strict conditions) is made to buy an asset that a SMSF is allowed.
• The asset is held in trust for the SMSF by a special type of trust.
• The SMSF collects the income from the asset and repays the loan, claiming interest as a tax deduction.
• Once the loan has been paid off, the asset transfers to the SMSF.

The example below gives some practical guidance as to how an investor could benefit from using this structure.

The types of assets that could be held under this arrangement include business real property, residential property (with certain conditions), and farming land. The opportunity also exists to provide access to margin lending for security investments.

The disadvantages initially will be costs of setup. The deeds for the required trust could cost between $6,000 and $9,000 depending on the finance arrangements. In addition, if a SMSF has not already been set up, there could be an additional setup cost of around $2,000 to $3,000 in legal and accounting fees.

Major Benefits

• Using a bank finance arrangement to purchase assets that otherwise would not be able to be purchased such as real estate including residential rental property.
• Using a bank finance arrangement to purchase business real property already held, freeing up cash currently tied up in superannuation with the possibility of reducing non tax deductible debt.
• Using a vendor finance arrangement where an in-specie contribution of assets to a SMSF would breach the contribution cap rules. This arrangement is more expensive to set up but can potentially allow large assets to be moved into the superannuation environment providing asset protection as well as tax benefits.

This arrangement will not benefit everyone and should be approached with caution. Do not enter into any purchases or borrowings without first seeking expert legal and taxation advice.

Example
Bank Financed Purchase of business real property – includes commercial, retail, industrial and farming.

Jonathan and Jane run an IT consultancy business which sells computers out of a shop in Noosa. The shop is on the market at $500,000. They are highly geared as Jane has just had the house fully renovated and they cannot borrow any more money.

Jonathan and Jane have $180,000 in superannuation between them.

• They take advice from one of our accountants and decide that they should use their super and borrow rather than lose the opportunity to get this prime real estate.2.They speak to their bank who are aware of the recent changes and agree to lend the money.
• They set up the required structure at a cost of $12,000.
• They sign a contract and complete the purchase by the new entity.
• The superannuation fund receives rent for the use of the shop by their business entity and claims allowable deductions including interest relating to the new property.
• The fund pays back the debt and the asset transfers out of the trust into the SMSF without Capital Gains or Stamp Duty applying.