I’ve had some regular dealings with a major financial institution relating to their SMSF instalment warrant loans and have recently been advised in respect to a change of policy with requiring personal guarantees (for some transactions) – I won’t mention the bank’s name, but by George they’re no Saint!! Big brother has obviously had a few words to them…
As many people would be aware the introduction of section 67(4A) into the SIS Act, opened a range of wonderful new strategies to leverage within an SMSF. In particular this has opened many doors to hold direct property inside an SMSF, whether it be residential or commercial (which can include your own business premises).
The exception contained in section 67(4A) of the borrowing provisions was legislated from 24 September 2007, however most professionals within the industry sat tight and waited patiently for the Australian Taxation Office (ATO) to release their position and concerns. This was subsequently released in April 2008, through Taxpayer Alert 2008/5 and a quite detailed question and answer document.
What this alert did consider was the issue of personal guarantees, where the lender imposes a personal guarantee from the fund members because of the limited recourse nature of the loan. Their primary concern was that in the event of default, the guarantor could seek recourse to recover any amounts against the fund trustees which exposes all fund assets, as opposed to the limited recourse over the acquired property that the lender can recover from.
It has been the view of most lending institutions to have had little regard for the regulator’s concerns and impose personal guarantees to protect their risk. Now, when I say risk, we are not talking about first home buyers here… we are talking about SMSFs, with an industry wide average balance of >$800k, with up to three levels of inflows to support repayments (rental income, contributions and income from other fund assets). Call me cynical, but further more when they are also typically providing lower loan-to-value (LVR) ratios than other loans, it appears almost ludicrous for the need for any sort of guarantee… but, that’s the banks for you!!
However, the ATO are now somewhat contradictory to their original taxpayer alert and concerns raised through the Q&A document. Why? Draft taxation ruling, TR2009/D3 – superannuation contributions discusses issues and provides examples of situations where in accordance with the exception of s.67(4A), where the lender provides a personal guarantee and the guarantor does not seek recourse against the fund trustees, then it will be deemed to be a forgiveness of debt and ultimately a contribution.
This draft ruling was due to be finalised in December 2009, however there has been no news to date… Some people within the profession have leapt onto this ruling as justification that guarantees are now ok – it is important to note is that it is still in draft form and could change in its final format?
So, where does this all leave us with respect to SMSF instalment warrant lending within an SMSF?
Part of the answer is quite easy. For many clients who can be the lender themselves (what I refer to as the BYO banker model), whereby you lend against your own equity in an asset (e.g. family home) and on-lend to the SMSF on commercial terms – personal guarantees are not an issue as you personally won’t be imposing such requirements on your own fund.
With respect to bank lending? I think it is very much ‘up in the air’… With a lack of clarity from the regulator, it would be prudent to have an LVR at a level where the lender requires no guarantee (which some banks will do), or alternatively ensure it has a strong servicing capability to again have any guarantees not imposed.
If banks require a guarantee, it would be worth putting in place some additional documentation that may either waive the rights of the guarantor to seek recourse against the assets of the fund (other than the property if still held), or otherwise prepared an irrevocable resolution that may require the trustees to sell the property if in the event of default and it hasn’t been remedied say within 28 days. Whatever the case, these are ‘workarounds’ and may need to be changed subject to any further ATO clarification or even any legislative change recommended through the Cooper Super System Review or Henry Tax Review.