Call Us Now 1300 309 551

  • SMSF - Instalment warrants and the capitalisation of interest

Normally self-managed superannuation funds (SMSFs) are prohibited from borrowing money or maintaining an existing borrowing of money. A limited exception to this, since 2007, is the limited recourse borrowing arrangement (better known as “instalment warrants”).

Capitalisation of interest

There has been some issue, in the past, over whether a capitalisation of interest causes SMSF instalment warrants to breach the no borrowing rule.

Capitalisation of interest occurs where the borrower may substitute, for the payment of interest on the borrowed amount, the mere drawdown of a further loan from the same lender. The further amount which must be repaid substitutes for the interest.

ATO’s approach to capitalisation

In the past the ATO has stated that capitalisation in this manner would breach the no borrowing rule, or that capitalisation is only permitted where the loan is a commercial-style product.

However, recently the ATO (following Government amendments to legislation) has stated that:

  • it remains true that each drawdown under a capitalised loan constitutes a new borrowing by the SMSF; and
  • despite this, these new loans will comply with SMSF law so long as the drawdowns are solely connected to the original borrowing and nothing else.

(Note that all the other instalment warrant rules must also be met, for instance recourse of the lender must remain limited to the originally acquired asset).

Example: Capitalisation of interest

B and C, who are members and individual trustees of a certain SMSF, determine that their SMSF will invest in a property located in Geelong VIC. However, the SMSF lacks the funds to acquire this investment without financing.

The SMSF applies to X Co, a bank, for a loan to acquire the Geelong property. The SMSF enters into the following arrangement:

  • the SMSF sets up a bare trust;
  • X Co lends the amount to the SMSF to acquire the property;
  • the bare trust actually holds the property, with the SMSF as the sole beneficiary;
  • X Co’s recourse is limited to the property itself; and
  • the SMSF will acquire legal title to the property upon making six payments including interest.

B and C also owe money to X Co on their own account, for the acquisition of a tractor for their farm. They have been having great trouble keeping up with payments for the tractor.

B and C as SMSF trustees determine that the SMSF wishes to capitalise the interest on its loan, since this would be financially the better course. However, X Co is tired of B and C’s continued inability to repay their own tractor loan.

X Co therefore permits the SMSF to capitalise its loan by drawing down more from X Co. However, X Co demands that the SMSF draw down a larger amount than usual, to make up for the late payments on B and C’s tractor loan.

In this case, the original arrangement would appear to satisfy the requirements for SMSF instalment warrants.

However, the proposed capitalisation would be in breach of the no borrowing rule for the SMSF. The capitalisation of interest is permitted, but must relate solely to loan for the original asset held by the bare trust. It cannot relate to any other loan.

Conclusion

If you have concerns over your SMSF and the capitalisation of interest, call LAC Lawyers and we can provide advice and assistance.

 

Want to speak to a lawyer right away?

1300 309 551
 

SMSF - Instalment warrants and the capitalisation of interest Articles

Self Managed Superannuation Funds (SMSF) - Borrowing a New Amount to Repair an SMSF Instalment Warrant Asset

Date: December 02, 2011
Author(s): LAC Lawyers
An issue raised before the ATO very recently is whether a self-managed superannuation fund (SMSF) is permitted to borrow a new amount to repair an instalment warrant asset it already holds. As we have discussed in previous articles, an SMSF is generally prohibited from borrowing money. However, an exception is available for limited recourse borrowing arrangements (better known as instalment warrants) in which the SMSF borrows money to pay for an asset that is held in a property trust and only transferred to the SMSF when the amount is paid off.

Self Managed Superannuation Funds (SMSF) - Can an SMSF Carry on a Business? Part 1 of 2

Date: December 02, 2011
Author(s): LAC Lawyers
An old question relating to self-managed superannuation funds (SMSFs) is whether they are permitted to carry on a business. This is the first in our two part article on the ATO’s attitude to such activities, which is ambiguous and contains many pitfalls for the unwary.

Self Managed Superannuation Funds (SMSF) - Can an SMSF Carry on a Business? Part 2 of 2

Date: December 02, 2011
Author(s): LAC Lawyers
In Part 1 of this article, we looked at the ATO’s general disapproval of the carrying on of businesses by self-managed superannuation funds (SMSFs). This part of the article will look at the ATO’s apparent change in attitude to this issue. However we will analyse the real effect of the ATO’s new publication and warn about how little has really changed.

Self Managed Superannuation Funds (SMSF) - In-specie Payments by an SMSF

Date: December 02, 2011
Author(s): LAC Lawyers
It has always been accepted that a self-managed superannuation fund (SMSF) can make lump sum payments in specie. What is not so clear is what happens when a lump sum is paid as a commutation of part of a superannuation income stream. This issue, which has sometimes arisen in the past, has been brought recently before the ATO.

Self Managed Superannuation Funds (SMSF) - Insurance and SMSFs

Date: December 02, 2011
Author(s): LAC Lawyers
In our article entitled SMSFs and personal injury liability we discussed the idea of a self-managed superannuation fund (SMSF) obtaining public liability insurance to protect itself against personal injury claims. In this article, we will discuss forms of insurance that the SMSF can obtain over its members. This can include life insurance, disability insurance and trauma insurance. The effect of such insurance upon the SMSF has been the subject of recent debate.

Self Managed Superannuation Funds (SMSF) - Partial Lease by an SMSF of an In-house Asset

Date: December 02, 2011
Author(s): LAC Lawyers
It is well-known that an exception to the restriction on in-house assets held by a self-managed superannuation fund (SMSF) is the real property exception, under which the property is leased to a member or related entity for business purposes. One issue that has arisen recently is what happens when the in-house asset is only partially leased.

Self Managed Superannuation Funds (SMSF) - SMSFs and ESS interests

Date: December 02, 2011
Author(s): LAC Lawyers
An employee share scheme (ESS) is a scheme under which an employer provides shares or options (ESS interests) to employees at a discount. Unfortunately, the ATO has noted many instances of employees nominating their self-managed superannuation fund (SMSF) as the acquirer of ESS interests under an ESS. While employees may generally nominate another party as the acquirer of ESS interests, nominating the SMSF gives rise to serious issues, as we shall see.

Self Managed Superannuation Funds (SMSF) - SMSFs and Personal Injury Liability

Date: December 02, 2011
Author(s): LAC Lawyers
It may seem obvious, but self-managed superannuation funds (SMSFs) can be liable in their own right to personal injury litigation. Liability for personal injury caused by faults in property will normally fall under the tort of negligence. Under tort law, property owners have a common law duty of care to all individuals on their premises. If the required standard of care is not met, and injury occurs to the tortfeasor in a reasonably foreseeable manner, then the property owner is liable for negligence.

Self Managed Superannuation Funds (SMSF) - SMSFs and Rectifying In-house Asset Breaches

Date: December 02, 2011
Author(s): LAC Lawyers
A non-complying self-managed superannuation fund (SMSF) is open to all sorts of penalties. However, there is often some leeway for breaches, provided action is taken quickly. This article deals with the rectification of a breach of the in-house asset rule.

Self Managed Superannuation Funds (SMSF) - SMSFs and Tax Exemptions on Pension Assets

Date: December 02, 2011
Author(s): LAC Lawyers
Once a self-managed superannuation fund begins to pay income stream benefits (ie a pension) to any of its members, it can begin to claim a tax exemption on income earned on assets it holds that are being used to produce the pension. This article deals with the nature of this exemption and the misunderstandings that sometimes arise.

Self Managed Superannuation Funds (SMSF) - Stepchildren and SMSF Death Benefits

Date: December 02, 2011
Author(s): LAC Lawyers
The rules applicable to self-managed superannuation funds have restrictions on who can receive cashed out member benefits. One rule is that member benefits may be cashed in favour of a member’s dependants, if the member dies. One issue that has been raised recently is whether the ATO would accept a stepchild as the dependant of its step parent if its natural parent dies first or the pair divorce. This is apparently an issue that has already come up quite often in Australia.

Self Managed Superannuation Funds (SMSF) - Excess Contributions Tax – Release Authority

Date: November 28, 2011
Author(s): LAC Lawyers
If an individual makes contributions to his or her self-managed superannuation fund (SMSF) and these contributions exceed the caps relevant to that type of contribution, then the individual may be liable to excess contributions tax (ECT).

Self Managed Superannuation Funds (SMSF) - Income Streams – When They Start

Date: November 28, 2011
Author(s): LAC Lawyers
When a member of a self-managed superannuation fund (SMSF) satisfies a condition of release, he or she may be eligible for an income stream benefit from the SMSF. When a member is receiving an income stream of this sort, it can be highly relevant for tax purposes (both for the member and the SMSF) to determine exactly when the income stream commences and ceases. The ATO has just released draft guidelines on how to determine these times (Draft Taxation Ruling TR 2011/D3).

Self Managed Superannuation Funds (SMSF) - Losses on Disposal of Shares

Date: November 28, 2011
Author(s): LAC Lawyers
A self-managed superannuation fund (SMSF) is generally discouraged from engaging in business. Although the ATO and Parliament have failed to make any binding statements on this point, it is fairly clear that they expect this point to be followed. A related issue that has clearly been vexing the Government and the ATO in recent times has been that of the treatment of SMSF share sale losses.

Self Managed Superannuation Funds (SMSF) - New Guidance for SMSF Instalment Warrants

Date: November 28, 2011
Author(s): LAC Lawyers
New draft ATO guidance is now available for the use of instalment warrants by self-managed superannuation funds. The instalment warrant system (officially “limited recourse borrowing arrangements”) permits SMSFs to borrow money, under restricted circumstances, to acquire an asset. However, many SMSFs attempting, or claiming to attempt, to use the instalment warrant system honestly, have been in breach of the rules, hence the new guidelines (Draft SMSF Ruling SMSFR 2011/D1, released September 2011).

Self Managed Superannuation Funds (SMSF) - Recording SMSF Contributions

Date: November 28, 2011
Author(s): LAC Lawyers
The Commissioner of Taxation has taken advantage of two recent cases before the Administrative Appeals Tribunal (AAT) to emphasise the importance of proper record-keeping by self-managed superannuation funds (SMSFs). He also emphasized the duty tax agents have to ensure that client SMSFs are not financially disadvantaged.

Self Managed Superannuation Funds (SMSF) - SMSF Auditors

Date: November 28, 2011
Author(s): LAC Lawyers
Every self-managed superannuation fund (SMSF) is required to arrange an annual audit of its accounts, statements and compliance. Audits must be carried out by an “approved auditor”. The SMSF trustee appoints an approved auditor every year and must provide the auditor with all documents needed for the audit. All audits must be in writing and highlight any important issues that may arise.

Self Managed Superannuation Funds (SMSF) - SMSFs and Non Arm's Length Income

Date: November 28, 2011
Author(s): LAC Lawyers
A self-managed superannuation fund (SMSF) is concessionally taxed at a very low rate. There is naturally a temptation in some quarters to exploit this fact by using an SMSF to help split income. However, the ATO has recently warned that the widespread abuse of an SMSF in this manner, whether the members believe it to be legal or not, is not in accordance with the law.

Self Managed Superannuation Funds (SMSF) - Winding Up an SMSF

Date: November 28, 2011
Author(s): LAC Lawyers
There comes a time in many instances when a self-managed superannuation fund (SMSF) must be wound up. Yet the Commissioner has recently warned that winding up procedures are frequently not being followed by SMSF trustees. In essence, the task of the SMSF trustee when winding up the SMSF is: to deal with all of the SMSF’s assets so that none remain; and to complete all administrative obligations.

Self Managed Superannuation Funds (SMSF) - Early Release Schemes

Date: November 25, 2011
Author(s): LAC Lawyers
For several years now, the Commissioner of Taxation has been making public his disapproval of schemes that illegally promise the early release of self-managed superannuation fund (SMSF) benefits. These types of scheme apparently have not disappeared, for the Commissioner has once more targeted them in his 2011-12 compliance program for SMSFs. Indeed, this year it would be wise for all SMSF trustees to familiarise themselves with the nature of this common and potentially disastrous form of illegal scheme.

SMSF - Instalment warrants and the capitalisation of interest FAQs

SMSF - Instalment warrants and the capitalisation of interest Lawyers

Frank Egan B.A., LL.B., A.C.L.A., F.T.I.A. (Notary)

Position: Chief Executive Officer
Frank Egan is the Managing Director of LAC Lawyers and has over 30 years experience as a lawyer. Frank heads up our taxation group and specialises in both onshore and offshore taxation arrangements including tax havens. He does not deal with any indirect taxation matters e.g. land tax, stamp duty or payroll tax. He is available to advise clients whether corporate or private on large, serious or complicated matters.

Michael Pickering B.A., LL.B. (Hons.), LL.M., M. A.

Position: Senior Solicitor
Michael Pickering is our most senior solicitor employed in the Melbourne Branch of LAC Lawyers Pty Ltd. He deals with a wide range of matters. He has over 30 years experience as a lawyer which he applies for the benefit of clients whether large or small.

Jonathan Lim BA (Hons II) LLB (Hons I)

Position: Solicitor
Jonathan practices exclusively in Australian and International tax and superannuation law. His specialty is the handling of negotiations with the ATO with respect to serious non-compliance by high net worth individuals and businesses, particularly over many years. He also advises on business structures, offshore tax issues and self-managed superannuation fund compliance.

SMSF - Instalment warrants and the capitalisation of interest Links

Client Testimonial

"I just wanted to say ?Thank YOU? for your sincere advice and guidance on my Tax issues & concerns."

"I would like to take this opportunity to thank LAC Lawyers for your support in handling my Family Law Case throughout this stressful period in my life "

"Thank you for all of your help. The service was outstanding - all of my questions were answered promptly, everything ran smoothly"

"Thank you for all your help in getting such a great result! I honestly don''t think I could have had the success I did without your assistance. So again, thank you!"