09/12/2010

It is important to understand the implications of redraw and refinance arrangements for limited recourse borrowing in self managed superannuation funds (“SMSF”). 

Under the limited recourse borrowing rules, each redraw or drawdown of funds from a loan facility involves a new borrowing that may be made within the same or original borrowing arrangement. 

On the other hand, refinancing involves entering into a new limited recourse borrowing arrangement, usually at the time of the re-financing.

Refinancing pre 7 July 2010 limited recourse borrowing facilities

1. A limited recourse borrowing arrangement may be refinanced, both under the former section 67(4A) and the new sections 67(A) and 67(B) of the SIS Act 1993.
2. A deemed refinancing arrangement may result if the terms of an existing borrowing arrangement are so varied that the original arrangement can be considered to have come to an end and a new borrowing to have taken place.
3. If the terms of a pre 7 July 2010 superannuation borrowing arrangement under the former section 67(4A) are fundamentally changed on variation, a refinanced arrangement will be deemed to have taken place.  If this is the case, the grandfathered former section 64(A) provisions will no longer apply. The new arrangement will have to meet the requirements of sections 67(A) and 67(B) on limited recourse borrowings, if the refinancing occurs on or after 7 July 2010.
4. The grandfathered former section 67(4A) contains various flexible provisions which are no longer available under the new rules.  If the intension is to preserve the grandfathered provisions, careful drafting of the documentations will be required whenever a former section 67(4A) loan or borrowing arrangement is to be varied or re-structured.
5. Some of the flexibilities available under the former section 67(4A) include:
   • The ability to gear into a portfolio of shares instead of a single shareholding of identical shares of the same market value  as required under the new rules;
   • The ability to apply the money borrowed to property improvement;
   • In the event of a call on the personal guarantee, it is possible for a guarantor under a section 67(4A) loan arrangement to have recourse over the SMSF assets through the SMSF trustee, despite the limited recourse nature of the loan facility.
   • More flexible replacement assets rules.
6. As a guideline, below are some of the factors that the Australian Taxation Office (“ATO”) will take into consideration to determine whether a refinancing has taken place.
   • Whether the original loan agreement provided for the parties to agree to extend the term
   • The period of extension in relation to the period of the original loan
   • Whether other terms of the loan were changed by the later agreement.

Implication of redraw or new drawdown of funds

1. Both the former section 67(4A) and the new sections 67(A) and 67(B) permit redraw facilities in limited recourse borrowing arrangements.  However, each new drawdown of funds is construed to constitute a “separate borrowing”.
2. A redraw of funds is usually applied to cover expenses in connection with the borrowing or acquisition of the acquirable asset, or in maintaining or repairing the asset.  These purposes are explicitly permitted when section 67(A) was enacted.
3. The Australian Taxation Office (“ATO”) has also confirmed in ID2010/184 that the money withdrawn to cover interest payments can also be capitalised.

Nexus between each draw down and the acquirable asset

1. This has been clarified by the ATO ID 2010/184.  Although each new drawdown of funds is a separate borrowing, it is not necessary to enter into a new borrowing arrangement upon each redraw.  The drawdown must be applied to the acquisition of the property or asset being acquired by the trustee under the limited recourse borrowing arrangement.  This requirement is satisfied if the cost is “related solely to the original borrowing under an arrangement that meets the requirements of former paragraph section 67(4A)”.  This also applies to arrangements under the new section 67(A).
2. Therefore the nexus between drawdown and acquisition is met as long as the funds on the redraw is applied towards the original acquirable asset or relates solely to the original borrowing, whichever is the case.
3. This is also consistent with the ATO Q&A on Limited Recourse Borrowing Arrangements for SMSFs.  In relation to maintenance and repairs, the ATO considers that the money borrowed can only be used for expenses incurred in maintainance or repairs as it relates to the acquirable asset.  It is not possible to simply borrow money to maintain or repair an existing asset of the fund.
4. It is also possible for the SMSF to pay incidental expenses and maintenance of the acquirable asset out of its own funds.  This will avoid extensive paper trails to show the nexus between each drawdown and the original borrowing or the acquirable asset.
   

SMSF limited recourse borrowings require proper documentation.
TOWNSENDS BUSINESS & CORPORATE LAWYERS has a complete establishment package on SMSF limited recourse borrowing including detailed advice on the following:

• Security trust deed
• Loan Agreement
• Mortgage documentation
• Advice letter to clients
• Trustee minutes
• Stamp Duty advice for each state

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